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Should You Consider Converting Retirement Savings to a Roth IRA?

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Both traditional IRAs and Roth IRAs are great ways to save for retirement, but the characteristics of the two are nearly opposite in nature. With a traditional IRA, you can get a tax deduction on contributions but you’ll owe tax on your future withdrawals. With a Roth IRA, you can’t deduct your contributions but your qualifying withdrawals will be tax-free.

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If you already own a traditional IRA, you may be able to convert it into a Roth IRA. Whether or not this is a good choice depends on a number of factors, however, from your age and tax bracket to your income level. Here’s a look at the pros and cons of converting your retirement savings into a Roth IRA

Consider Your Age

If you’re getting close to retirement age, converting to a Roth may not be in your best interest, particularly if you’ve amassed a large nest egg. At that point, you’re likely in your peak earning years, meaning you’re in your highest tax bracket. Converting to a Roth may push you into an even higher tax bracket, since you’ll immediately have to pay taxes on the entire value of your account. It will also remove your flexibility to devise a tax-efficient withdrawal strategy in retirement.

Retire Comfortably

If you’re young, on the other hand, converting to a Roth may make sense for a number of reasons. First, you’re likely in a lower tax bracket, as your earnings have not yet peaked, and the size of your retirement account is also likely to be much smaller. By paying this smaller tax now, you’ll be able to grow your retirement account tax-free for the bulk of your life, and your future retirement distributions will also be tax-free.

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Consider Your Tax Bracket

Your tax bracket is an important factor to consider when choosing between keeping a traditional retirement account and converting it to a Roth IRA. If you’re in a high tax bracket, the scales may tip toward a traditional retirement account. For starters, you’ll get a bigger tax deduction on your contributions. You’ll also avoid the high taxes you’d owe if you converted to a Roth IRA, as your entire balance is fully taxable at ordinary income rates. If your tax rate in retirement ends up being lower than when you are working — which is likely if you’re a high earner — then you’re potentially in a worst-case scenario if you convert, as you’ll pay higher taxes now rather than paying lower taxes after retirement. 

Retire Comfortably

However, the opposite is also true. If you’re in a low tax bracket now, you won’t be paying as much tax when you convert, and you may find that your tax bracket ends up being higher after you retire for any number of reasons. If you build up your retirement accounts to a high level, for example, your income may actually rise after retirement. It’s also entirely possible that tax brackets themselves may rise in the future. 

Consider Your Income

In addition to the tax situations created by your income level, there are also limitations to when you can contribute to a Roth IRA. For tax year 2022, joint filers cannot contribute to a Roth IRA when their income exceeds $214,000. The limit for single and head-of-household filers is $144,000.

Although there is no income limit for Roth conversions, it doesn’t always make sense to convert to a Roth IRA if you can’t continue making future contributions to it.

Retire Comfortably

The Bottom Line

Many financial advisors recommend that investors diversify their retirement accounts among both traditional and Roth IRAs. This gives you the flexibility to make tax-deductible IRA contributions in your high-income years and make after-tax contributions to a Roth IRA when your income is lower. This will also give you the most options for drawing income after you retire, as you can take a variety of distributions in the most tax-efficient way.

You can also avoid required minimum distributions on the assets that you hold in a Roth IRA. But as each individual’s tax and financial situation is different, you should consult with your tax and/or financial advisors about whether or not you should be converting your retirement savings to a Roth IRA.

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