Couple discussing IRA to Roth conversion
Couple discussing IRA to Roth conversion

IRA to Roth conversion: Should you change your retirement plan? 

Roth conversion (converting from a Traditional to a Roth IRA) can be an attractive prospect when the market is down; you can move your balance to the Roth IRA while the taxable amount is lower and then let it grow tax-free in the Roth account. There are various reasons to convert a Traditional IRA to a Roth, and—with the S&P 500 surrendering about 18% over the past 12 months—now may be a good time for some account holders to consider doing so. Would a conversion be beneficial to you? Read on to find out. 

First, a quick reminder of the differences between a Traditional IRA and a Roth IRA:

Traditional IRA

  • You deduct your contributions in the year that you make them
  • This lowers your taxable income that year
  • You don’t pay any tax on the earnings until you get to the point of withdrawing funds
  • When you withdraw the income in retirement, you pay taxes on your distributions

Recommended for: People who expect to be in an equal or lower tax bracket in retirement than during their working years.

Roth IRA 

  • Contributions are made with after-tax dollars
  • You don’t receive a tax deduction during your working years
  • Earnings on qualified distributions are not taxed, so you get tax-free withdrawals in retirement

Recommended for: People who expect to be in a higher tax bracket in retirement than during their working years, such as those investing early in their career, and those whose salaries are likely to increase as they progress in their careers.

2023 income and contribution limits 

Both Traditional and Roth IRA accounts have rules about the amounts you can contribute each year based on your income and age. The maximum total annual contribution for all your IRAs combined for 2023 is $6,500 if you’re under 50; $7,500 if you’re 50 or older. 

The below income-based limits for Roth IRAs are expressed as Modified Adjusted Gross Income (MAGI):

Traditional IRARoth IRA 2022Roth IRA 2023
Single personNone$144,000$153,000
Joint filer None$214,000$228,000

If your income puts you above a Roth IRA’s limits, you can open a traditional IRA and convert it to a Roth IRA immediately. Congress removed income restrictions for Roth IRA conversions, allowing taxpayers to take a backdoor approach and offering the benefits of a Roth to even more people. 

How much does it cost to convert?

Because you haven’t paid taxes on any of the funds in your Traditional IRA, you’ll have to pay the taxes on the converted amount. Once the conversion is complete, earnings and distributions are not subject to tax. Because the market is down at the moment, some investors will be able to benefit from converting at a lower cost than usual. 

For example, let’s say you own ten shares, each worth $100, in your Traditional IRA account. If you choose to convert your Traditional IRA to a Roth IRA, you’d owe taxes on $1,000 (the dollar value of the shares). But, if your portfolio declines by 20%, you’ll only pay taxes on moving the current value of the shares ($800). Ideally, once converted, these stocks will continue to grow tax-free in your Roth IRA account until you’re ready to retire. 

Is now a good time to convert from a Traditional IRA to a Roth IRA?

Everyone’s circumstances are different, so it’s worth speaking to your financial advisor about your Roth IRA conversion. Here are some factors to consider:

  • If your IRA has lost value in the current economic climate, you may be able to take advantage of a lower conversion tax if you convert before the market recovers. That being said, converting may not be advisable if you still expect to be in a lower tax bracket in retirement.
  • If you rolled a Traditional IRA to a Roth IRA and the Roth IRA lost value, you are effectively paying taxes on the loss.
  • Converting when tax rates are relatively low may be advantageous.
  • If you’ve lost income or project a loss for the year, you may be in a lower tax bracket than usual, thus reducing the conversion cost.
  • You pay taxes on the conversion from the Traditional IRA to the Roth IRA. Can you pay these taxes without using the IRA funds themselves? In an ideal situation, you have enough cash on hand to pay the tax due, which will enable you to reap the full tax benefits as the Roth IRA continues to grow over time.
  • If you’re on Medicare, remember that your conversion income may impact your Medicare premiums in years to come.
  • The 2017 Tax Cuts and Jobs Act terminated the ability to reverse a conversion for tax purposes, so you won’t be able to recharacterize your Roth conversion to a Traditional IRA.

Because of all the nuances and potential tax implications, it’s worth consulting a professional when looking into converting your IRA to a Roth IRA. We can run the numbers and help you proceed with the best decision for you at this time and for your unique circumstances. For additional tax strategies for retirement, please check out our previous blog entries, and don’t hesitate to contact us if you have any questions.

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