By Allen Giese, CLU®, ChFC®, ChSNC®, and ChatGPT

If you’ve ever considered converting your traditional IRA to a Roth IRA, you’ll know that the decision to proceed comes down to whether it makes sense to pay the taxes on the converted dollars now or later. Proceeding with the conversion means the benefits of having that money in a Roth IRA outweigh the downside of paying the taxes on the traditional IRA today.

Converting a traditional IRA to a Roth IRA can be a strategic move for many investors, offering benefits that can enhance your financial security and retirement planning. Basically, converting to a Roth IRA is changing the character of the IRA from an account that has never been taxed and will get taxed when you withdraw money to an account that will most likely never see any taxation going forward. You just have to pay the taxes due on the traditional IRA at the point of conversion. Although this decision has significant current tax implications, the long-term advantages can outweigh the short-term costs.

Let’s take a look at why converting to a Roth IRA might be the right choice for your retirement strategy.

Tax-Free Withdrawals in Retirement

One of the most compelling benefits of a Roth IRA is that qualified withdrawals are tax-free. Unlike a traditional IRA, where withdrawals during retirement are taxed as ordinary income, a Roth IRA allows you to withdraw your money without any tax liability, provided you meet certain conditions, such as being at least 59 ½ years old and having held the account for a minimum of five years.

This tax-free income can be especially beneficial if you anticipate being in a higher tax bracket during retirement than you are now. It provides a hedge against future tax increases and helps ensure you can enjoy more of your savings when you need them most.

No Required Minimum Distributions (RMDs)

Traditional IRAs require account holders to start taking minimum distributions at age 73 (age 75 if you were born after December 31, 1959), whether they need the money or not. These RMDs can push you into a higher tax bracket and potentially increase your overall tax burden in retirement.

In contrast, Roth IRAs have no RMDs during your lifetime. This allows your investments to grow tax-free for as long as you live, giving you greater control over your retirement funds.

This feature is particularly advantageous if you don’t need to tap into your retirement savings immediately and prefer to let your investments grow or if you plan to leave the account to heirs.

Tax Diversification

Converting to a Roth IRA provides tax diversification in your retirement portfolio. By having both Roth and traditional accounts, you can strategically manage your taxable income during retirement.

For example, you could withdraw from your traditional IRA in years when your income is lower and tap into your Roth IRA when your income is higher, potentially minimizing your tax liability over the course of your retirement.

This flexibility can be particularly valuable in uncertain economic times, as it allows you to adapt your withdrawal strategy to changing tax laws and personal circumstances.

Estate Planning Advantages

A Roth IRA can be a powerful tool for estate planning. Since Roth IRAs do not have RMDs during the account holder’s lifetime, the account can continue to grow tax-free, potentially leaving a larger inheritance for your heirs. Moreover, Roth IRA beneficiaries can withdraw funds tax-free, which can be a significant benefit compared to inheriting a traditional IRA, where distributions are taxed as income.

This tax-free inheritance can be particularly beneficial for heirs who are in higher tax brackets, allowing them to retain more of the inherited assets.

Potential for Lower Taxes Over Time

Although converting to a Roth IRA requires paying taxes on the amount converted, doing so can lead to lower overall taxes in the long run. This is especially true if you expect your future tax rate to be higher. By paying taxes now at a potentially lower rate, you can avoid paying taxes on your withdrawals later when tax rates may be higher.

Converting a traditional IRA to a Roth IRA can provide substantial benefits, including tax-free withdrawals, no RMDs, tax diversification, and estate planning advantages. While the upfront tax cost can be significant, the long-term benefits often make this conversion a wise financial move for many investors.

Have questions about whether a Roth IRA conversion would be good for you? Call us! Let’s take a look to see if a Roth IRA conversion aligns with your overall retirement strategy and financial goals.