Navigating the Roth Conversion Window

Elizabeth Hutton, CFP®, Financial Planner

In this episode of Street$marts, Elizabeth Hutton, Vice President and Financial Planner at Howe & Rusling, delves into the intricacies of Roth Conversions. Discover how high earners can navigate Roth IRA contribution limits, and explore the strategic "Roth Conversion Window" between retirement and required minimum distributions. She will guide you through the criteria for optimal candidates, shed light on critical considerations, and unveil the strategic benefits, from mitigating future tax risks to enhancing estate planning.

1. So what exactly is a Roth conversion?  

Taking a quick step back, let’s review what a Roth IRA is. A Roth IRA is an individual retirement account that is funded with after-tax dollars, with the benefit being that all contributions can then grow tax-free and serve as a means of tax-free retirement income, provided certain conditions are met. Because of the robust tax benefits that Roth IRAs offer, limitations are posed on contributions. To make a Roth contribution you must have earned income, however if your income is greater than a specific amount then you are not permitted to contribute to a Roth IRA.  For 2023 these limits are $153,000 for single filers and $228,000 for married couples filing jointly. In addition to the income restrictions, there is a limit on the amount you are allowed to contribute annually.  In 2023, the contribution limit is $6,500 (plus an additional $1,000 for those 50 and older).  

With these restrictions in mind, you may be thinking to yourself, “So as a high earner does that mean I will never have the opportunity to get funds into a Roth account?”. Luckily for us, another method can be used to get funds into a Roth IRA, and this is where Roth conversions come into the picture. If you have a tax-deferred retirement account such as a 401(k) or Traditional IRA, you can actually convert those dollars to a Roth IRA and pay income taxes on that amount in the current year. In other words, a Roth conversion is simply the process of moving Traditional IRA assets into Roth IRA assets. Unlike Roth contributions, Roth conversions do not have income or contribution limits.  

2. Is there a particular time of my life when Roth Conversions would be the most appropriate/beneficial? 

So how can you determine if a Roth Conversion is right for you? Ideal candidates for Roth conversions tick the following three boxes:  

  • You are in a low-income tax bracket, which most likely means you are no longer earning any significant work-related income. 
  • You have not yet reached the age at which you are required to take minimum distributions (RMDs) from your pre-tax retirement accounts. At this point you will be required to draw down your pre-tax retirement accounts, and these annual withdrawals will be fully taxable, most likely bumping you up to a higher income tax bracket. The start of RMDs age varies from age 73 to 75 depending on your birth year. 
  • You have ample cash savings to cover the additional tax obligation generated by the conversion. 

Bearing in mind these conditions, we tend to see the period between retirement and RMD age as the “Roth Conversion Window”; the sweet spot for implementing a Roth Conversion strategy.  

In addition to knowing when would be best to convert these dollars from pre-tax to after-tax accounts, there are some other considerations. Unfortunately, there is a 5-year holding period associated with withdrawals of the principal and earnings amount of a Roth conversion. Therefore, make sure that you won’t need the money within the next 5 years, or those withdrawals could be subject to tax and penalties. Additionally, unlike a contribution to an IRA that can be completed until the tax deadline of the following year, conversions of funds from Traditional IRAs to Roth IRAs need to be completed during the calendar year. The last quarter of a calendar year is a great time to evaluate a Roth Conversion strategy because you mostly will have a ballpark idea of your annual income.  

3. Why should I consider doing a Roth Conversion? 

Roth conversions may provide a method to mitigate the risk of potential higher future tax rates. Since Roth IRAs do not have required minimum distributions, it can be beneficial to convert assets from a traditional IRA to a Roth IRA to lower future RMDs and thus future tax liability.  

Additionally, because Roth IRAs do not have RMDs of their own, these investments can reap the benefits of uninterrupted growth and compounding. 

My personal favorite reason for a Roth conversion focuses on estate planning.  Due to the enactment of the SECURE Act, retirement assets including both traditional and Roth IRAs are subject to the new rule stating that the entire balance of the inherited asset must be distributed within 10 years. For traditional IRA assets, this potentially creates a significant tax burden for heirs if they receive these assets in their peak earning years. Roth IRAs, however, are tax free in nature and would not cause their heirs to incur any tax liability, thus, providing your heirs with more flexibility in the event of your passing. 

4. Okay, based on the information provided I think I’m a good candidate, but how do I know if a Roth conversion strategy is right for me?  

Roth rules are complex and just one of many considerations for retirement. At Howe and Rusling, our Financial Planning team is here to help! We can take the guesswork out of it and assess the detailed benefits of a Roth Conversion for you in relation to your unique financial goals to help ensure that implementing a Roth Conversion will be most beneficial for your circumstances. Thanks for tuning into StreetSmarts today, and I’ll see you next time. 

Disclosures: Tax codes are current as of the date published and are subject to change without prior notice. A professional designation, certification, degree, or license, membership in any professional organization, or any amount of prior experience or success, should be construed by a client or prospective client as a guarantee that the client will experience a certain level of results if the investment professional or the investment professional’s firm is engaged, or continues to be engaged, to provide investment advisory services. No professional designation should be construed as an endorsement by any past or current client of the investment professional or the investment professional’s firm. A long-term investment approach cannot guarantee a profit. While H&R believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information. This communication may include opinions and forward-looking statements.  All statements other than statements of historical fact are opinions and/ or forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the beliefs and expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such beliefs and expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements. All expressions of opinion are subject to change. You are cautioned not to place undue reliance on these forward-looking statements. Any dated information is published as of its date only. Dated and forward-looking statements speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any dated or forward-looking statements.  

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