Roth individual retirement account conversions have seen a significant increase in 2024, with a 44% year-over-year rise in the number of conversions during the first quarter, according to data from Fidelity Investments. A Roth conversion involves transferring pretax or nondeductible individual retirement account funds to a Roth IRA, which offers tax-free growth in the future. While this option provides the potential for tax-free growth, it may not be suitable for everyone because it takes time for the tax-free growth to surpass the upfront tax bill, as stated by Marianela Collado, a certified financial planner and CEO of Tobias Financial Advisors in Plantation, Florida.
Before opting for a Roth conversion, individuals need to ensure they have “sufficient assets” outside of retirement accounts to cover the upfront tax bill, as highlighted by Collado. Moreover, one should evaluate how the additional income from the conversion impacts eligibility for certain tax breaks. Higher earnings may trigger income-related monthly adjustments for Medicare Part B and Part D premiums in the future. Factors such as the amount converted and tax brackets for the year play a crucial role in determining the tax consequences of a Roth conversion. Despite the initial tax implications, strategic Roth conversions can lead to substantial reductions in lifetime taxes or aid in legacy planning goals, according to Ashton Lawrence, CFP and director at Mariner Wealth Advisors in Greenville, South Carolina.
Roth conversions tend to be more appealing during market downturns, as individuals can convert more shares and benefit from tax-free growth during the market recovery. Lower-income years also present favorable conditions for Roth conversions, as they result in lower upfront taxes on the converted balance. Key opportunities for Roth conversions may arise after a job loss or early in retirement before claiming Social Security and commencing required minimum distributions (RMDs). With the elimination of the stretch IRA, more investors are turning to Roth conversions for legacy planning purposes. Inherited IRAs must now be emptied within a 10-year window since 2020, leading to potential tax burdens for heirs during their peak earning years.
Roth conversions offer various benefits, including tax diversification, lower RMDs, and enhanced inheritance planning, as outlined by CFP Wes Battle with Financial Advantage Associates in Rockville, Maryland. Certain investors are capitalizing on conversions while tax brackets remain low, anticipating higher individual tax brackets post-2025 as provisions from the 2017 tax overhaul expire. However, the future of these tax breaks remains uncertain, pending changes in control of the White House and Congress. Baby boomers, in particular, with substantial pretax retirement balances are exploring Roth conversions to mitigate tax liabilities once RMD age is reached. By assessing the nuances of Roth IRA conversions and considering individual financial circumstances, individuals can make informed decisions to optimize their retirement savings and tax planning strategies.