Roth IRA conversions for retirees: Is this sweet spot the right time for you?

Many consider the time between retirement and age 72 the “Roth conversion sweet spot.”

This is because most people’s incomes drop after they retire and stay relatively low until they have to take required minimum distributions (RMDs) at 72. 

Being in a lower tax bracket is advantageous when converting a pre-tax retirement account to an after-tax Roth IRA because you pay less taxes on your transfer. 

Roth conversions for older individuals don’t make sense for everyone. Read on to find out if it makes sense for you.

A primer on the tax treatment of pre-and post-tax accounts

Unlike other types of retirement accounts that are funded with pre-tax money, Roth IRAs are funded with after-tax dollars. This means every dollar is taxed before it can go into your Roth IRA account.

The downside is that you can’t deduct your Roth contributions from your taxable income. However, the upside is that your Roth contributions—and any interest you earn—grow tax-free and can be withdrawn without paying taxes in retirement.

Related: Roth IRA vs traditional IRA: Differences, limits, pros and cons

How does a Roth IRA conversion work?

A Roth IRA conversion involves moving money from a pre-tax IRA or employer-sponsored retirement plan to a Roth IRA. Pre-tax IRAs include traditional, SEP, and SIMPLE IRAs; employer plans include 401(k)s, 403(b)s, TSPs, and others.

The catch: you must pay taxes on your pre-tax IRA funds before converting to a Roth IRA. This money has never been taxed, and the IRS won’t forget that you owe them. Since the amount you convert is considered taxable income, it’s extremely important to add this amount to your total annual income to see if the extra income will bump you up into a higher tax bracket.

2024 income tax brackets (for taxes due in 2025)

Source: IRS

Jumping tax brackets isn’t necessarily a reason to abandon a conversion, but it’s definitely something to factor into your decision. 

If your income fluctuates, you may want to consider converting during a year when your income is lower than average. Small business owners or commission-based salespeople are two examples of individuals with variable incomes.

When does a Roth IRA conversion make sense?

Since Roth IRA conversions have no income eligibility limits, otherwise ineligible savers, such as high earners, can participate. The reason is that Roth IRA contributions for high earners are limited or even prohibited without conversions.

For example, in 2024, income phase-outs for modified adjusted gross income (MAGI) begin at $146,000 for individuals and $230,000 for married couples filing jointly. If you make over $161,000 as an individual (or $240,000 if married filing jointly), you can’t contribute to a Roth IRA at all. 

Another consideration is the state in which you will retire. If you plan to retire in a high-income tax state, a conversion might make more sense than in a low- or no-income-tax state.

Pros and cons of converting a Roth IRA in retirement

Advantages to converting a Roth IRA in retirement

Roth IRA conversions aren’t just for young people who expect to pay higher taxes later in life. They can also benefit retirees who are earning less now than in their working years by lowering their conversion tax bill.

In some cases, people with large retirement account balances, pensions, Social Security checks, and RMDs end up in a higher tax bracket in retirement. 

One way to avoid the post-retirement tax burden is to convert a portion of your pre-tax money now into a post-tax account. Just remember, you have to pay taxes on your conversion dollars first.

Another reason is that Roth IRAs are exempt from required minimum distributions (RMDs). The IRS mandates these withdrawals annually after age 72, and they can create tax burdens for higher-income retirees. 

But since Roth IRAs are exempt from RMDs, you will potentially have more to leave to your heirs, creating greater generational wealth.

Drawbacks to converting a Roth IRA in retirement

Obviously, paying the IRS a sizable check is never fun, so that’s one drawback to consider.

Another downside is that Roth accounts must remain open for a minimum of five years to prevent taxes on any earnings withdrawn. This rule applies to every conversion.

So, if you convert in 2024, you will have to wait until 2029 to withdraw money without penalty. If you wait to convert in 2026, you won’t be able to access your funds penalty-free until 2031. 

Note: You can always withdraw your original contributions penalty-free.

This is why it’s so important to work with a team of experts who will monitor your conversion schedule and create a distribution strategy that aligns with your entire financial plan.

Finally, keep in mind that converting a regular IRA to a Roth IRA is irreversible. So, if you’re unsure whether your post-retirement taxes will decrease, it’s worth giving a second thought to the conversion.

Final word

For individuals expecting a lower tax rate in retirement, transitioning from a pre-tax retirement account to a Roth IRA may help reduce overall tax liability. Roth IRA conversions enable tax-free earnings growth and eliminate mandatory withdrawals that may increase taxes in retirement. Just remember that conversions require paying taxes now instead of later, and you must keep funds in the account for five years before taking tax-free withdrawals.

Tips on Retirement

Deciding whether to convert traditional IRA funds to a Roth IRA requires a thorough assessment of your financial and tax situation. This is where a financial planner can offer invaluable guidance. 

Find out how our process works and realize your financial goals today.