You’re standing at a crossroads, holding your retirement savings, and Uncle Sam is offering you two deals. Door number one? Pay him later when you’re older and wiser. Door number two? Pay him now, and he’ll call it even forever. That’s essentially the choice between Traditional and Roth retirement accounts, and honestly, it could be one of the most important financial decisions you ever make. Unfortunately, nobody has a crystal ball to see what tax rates will look like in 20 or 30 years, so we’re all making educated guesses. But hey, that’s what makes it interesting, right? Fortunately, we have ways of determining whether a conversion makes sense at all before making your decision.
Traditional vs. Roth: Pay Taxes Now or Later
Alright, first things first – what’s the difference between a Traditional and a Roth account?
Traditional IRA/401(k): You get a tax break now. Contributions are pre-tax, which lowers your taxable income today. The money grows tax-deferred. But when you withdraw in retirement, those withdrawals are taxed as ordinary income. In short, you’re saying, “I’ll pay the taxes later–promise.”
Roth IRA/401(k): You pay taxes on the money now (contributions are after-tax), but then it grows tax-free, and qualified withdrawals in retirement are tax-free. You don’t get a break upfront, but all the growth and earnings are yours to keep when you need them.
✓ Tax break now
Lower taxable income
Tax-deferred
No taxes while growing
⚠ Pay taxes on withdrawals
Ordinary income rates
⚠ Pay taxes now
After-tax contributions
Tax-free growth
No taxes on gains
✓ Tax-free withdrawals
Keep everything you earned
(Pay taxes now on converted amount)
Now, what about converting from a Traditional to a Roth? A Roth conversion means taking money from your Traditional account and moving it to a Roth. You can convert some or all of it. But remember, since that Traditional money hasn’t been taxed yet, you’ll owe income tax on whatever amount you convert (it’s as if you withdrew it). You can think of a conversion as pre-paying your retirement taxes. You’re settling up with Uncle Sam now in exchange for tax-free withdrawals later. Whether that trade-off is smart depends on a few things.
With that groundwork laid, let’s explore the scenarios when a Roth conversion might be a good idea and when it might not.
When a Roth Conversion Might Make Sense
Here are a few situations where converting to a Roth could be in your favor:
You Expect to Be in a Higher Tax Rate in Retirement
Current tax rates are relatively low by historical standards. (Did you know the top federal income tax rate was 94% during WWII? Crazy, right?) Today, the top rate is 37%. Meanwhile, the government’s got a $36 trillion debt tab, and the tax cuts from 2017 are set to expire after 2025. If Congress doesn’t act, tax brackets will jump back up in 2026, one analysis found that about 62% of taxpayers would get hit with a higher tax bill in 2026.
So ask yourself: Do you think taxes in the future will be lower, the same, or higher than they are today? If you believe taxes have more room to go up than down in the long run, then you’ll probably lean toward converting now (paying today’s rates and insulating yourself from future hikes). If you truly think you’ll be in a lower tax environment later, then keeping the Traditional account and paying taxes later might be the better route.
Roth Now vs. Traditional Later: A Quick Illustration
Let’s put some numbers to this with a simple example. Say you have $100,000 in a Traditional IRA right now. You’re considering converting it to a Roth. We’ll assume it grows at 6% per year for 20 years (just an example, not a prediction!). We’ll also assume your current tax rate is 25% for the conversion.
Scenario 1: No Conversion (Traditional stays Traditional). Your $100k grows tax-deferred to about $320k in 20 years. But remember, that’s all pre-tax. If in retirement you’re taxed at 25%, you’d net roughly $240k after taxes. If tax rates are higher (say 35%), you’d net around $208k after taxes.
Scenario 2: Convert to Roth Now. You pay 25% tax on that $100k today, leaving $75k going into your Roth. That grows to about $240k in 20 years. In retirement, because it’s a Roth, you keep every penny tax-free, no matter what the tax rates are.
The chart above shows the estimated after-tax money you’d end up with under different future tax rates. The blue bars are if you stick with the Traditional IRA, and the orange bars are if you convert to Roth. When future taxes are low (15%), the Traditional comes out ahead (about $273k vs. $240k). If future taxes stay the same (25%), Traditional and Roth end up about equal ($240k each). If future taxes are higher (35%), the Roth conversion comes out on top ($240k vs. $208k for Traditional). This illustrates that the benefit of a conversion largely hinges on where tax rates go.
You Have a Long Time Horizon
When you convert to a Roth, you can’t touch that converted money for five years without facing a 10% penalty (this is separate from the age 59½ rule). This “five-year clock” starts ticking from January 1st of the year you do the conversion, and it applies to each conversion separately. So if you’re thinking about a Roth conversion, you better be sure you won’t need that money anytime soon.
You Can Pay the Conversion Tax
If you have cash sitting in a savings account, a taxable brokerage account, or other non-retirement funds to pay the tax bill on a conversion, that’s a huge advantage. When you can pay the conversion taxes from outside sources, 100% of your retirement account balance gets to make the move to the Roth side.
Let’s say you want to convert $100,000 and you’re in a 25% tax bracket. If you have $25,000 in a regular savings account to cover the tax bill, then all $100,000 gets converted to Roth status. But if you don’t have outside money and have to use $25,000 from the retirement account itself to pay taxes, you’re only really converting $75,000. Plus, if you’re under 59½, that $25,000 you pulled out to pay taxes could trigger a 10% early withdrawal penalty. Ouch. Having outside money to pay the tax bill is like getting a volume discount – you maximize what actually makes it into the tax-free zone.
You Want to Avoid Required Minimum Distributions (RMDs)
Traditional (pre-tax) accounts force you to start taking money out at age 73—whether you need it or not. Those RMDs get added to your taxable income, which can
(1) push you into a higher tax bracket,
(2) bump up your Medicare Part B and Part D premiums via IRMAA (since IRMAA is based on your modified adjusted gross income), and
(3) make more of your Social Security benefits taxable (because the IRS looks at your “provisional income”—half of your Social Security plus all other income—to determine what percentage of benefits are taxed).
On the other hand, Roth IRAs and Roth 401(k)s have no RMDs during your lifetime, and qualified Roth withdrawals aren’t taxed or even counted as income for Medicare or Social Security purposes. If the idea of being forced to take taxable income in your 70s makes you wince, converting to Roth means you can let your money sit as long as you want.
Markets Have Taken a Dip
Market downturns can actually create great conversion windows. When your retirement account balance is down due to market volatility, you have a smaller dollar amount to convert, which means a smaller tax bill. You’re converting the same number of shares
If your account was worth $100,000 in January but drops to $80,000 during a market correction, converting that $80,000 means you only pay taxes on $80,000 instead of the full $100,000. But you still own the same investments in your Roth account. When the market recovers (as it historically has), all of that recovery growth happens in the tax-free Roth environment. You’ve essentially gotten a discount on your conversion tax bill while positioning yourself to capture the recovery tax-free.
You’re Thinking About Your Heirs
If you plan to leave money to your kids or other heirs, a Roth can be an excellent vehicle. You pay the taxes now, and they inherit the money tax-free later (under current rules). They will have to spend an inherited Roth within 10 years, but they won’t owe tax on those withdrawals. Converting can effectively pre-pay the taxes for your heirs, which could be a nice legacy move.
Ok, Roth conversions seem to be a clear win, right? Well, for balance, let’s look at the flip side.
When a Roth Conversion Might Not Make Sense
And now the reasons you might hold off on converting:
You Expect Lower Taxes in Retirement
If you’re in a high tax bracket now and will drop to a lower one once you stop working, converting now means unnecessarily paying a high rate. Why pay (for example) 32% on a Roth conversion today if you might only pay 22% on that money by taking it out slowly in retirement? In this case, sticking with the Traditional account and paying the lower rate later is smarter.
You Can’t Afford the Tax Bill Now
A conversion can come with a hefty tax bill. If you’d have to withdraw money from the retirement account itself to cover those taxes, that’s usually a deal-breaker. It not only shrinks the amount that actually gets into your Roth, but if you’re under 59½, you could incur penalties on the money you took out to pay taxes. Converting makes much less sense if it strains your cash flow or robs the conversion of its benefit.
Retirement Is Right Around the Corner
Generally, you want enough years post-conversion for the tax-free growth to compensate for the upfront tax. If you’re only a few years from retirement (or need this money soon), a conversion might not have enough time to pull ahead. In other words, don’t pre-pay a bunch of taxes now if you’re going to need that money in the near term anyway. Plus, as we mentioned above, you need to wait at least five years before you begin taking distributions.
A Conversion Would Bump You into a Higher Bracket:
Be careful of the “tax bracket creep.” Converting a large amount in one year can push you into a higher federal tax bracket (and possibly increase state taxes, Medicare premiums, etc.). It can also reduce eligibility for certain tax credits or deductions. To avoid this, many people do partial conversions over several years, converting just enough each year to stay in a reasonable bracket.
State Tax Considerations
Don’t forget state taxes. If your state has high income tax and you plan to move to a no-tax state in retirement (or vice versa), that should be factored in. You might delay conversions until after moving to a lower-tax state, or accelerate them if you know your state taxes will rise. The goal is to convert at the lowest overall tax cost possible.
In short, a Roth conversion comes with an upfront cost, and it might not be worth it for everyone.
Wrapping Up: What’s Right for You?
As with everything regarding retirement planning, the Roth conversion question boils down to your personal outlook and situation. It’s about paying taxes on your retirement savings when it’s most beneficial to you. Some people like the idea of ripping off the Band-Aid now and getting taxes out of the way. Others prefer to defer and hope for lower rates, or use that tax money for other priorities in the meantime.
Which do you prefer? If you’re like most Americans, you’re probably unsure, and you need some expert guidance. And that’s why I’m here! Ready to talk it through and see what’s best for your situation? Go ahead and click the button below to schedule a consultation. We’ll chat about your goals, break down the numbers, and come up with a plan that puts you in control of your financial future.
I look forward to hearing from you!
