Roth conversions can be an effective tax planning strategy, and there are key factors to bear in mind when considering transfering a traditional IRA into a Roth. Roth conversions can have a desirable effect on your Medicare, social security, and taxes. In this post regarding Roth conversions, our CPAs explain how you can convert a traditional IRA to a Roth IRA and explain the tax benefits of doing so.

At Steward Ingram & Cooper, PLLC, we advise ongoing clients on the type(s) of IRAs that are appropriate for their tax situations in our tax planning sessions. The key deciding factor when it comes to choosing a traditional IRA vs a Roth IRA is your predicted tax bracket in retirement. Join us as we take a closer look at a Roth IRA, compare it to a traditional IRA, and present reasons why you may want to convert your IRA to a Roth IRA.

roth conversions

Individual Retirement Accounts

The goal of an IRA (Individual Retirement Account), regardless of whether it is a Roth or a Traditional, is to provide income during a person’s retirement. You contribute money into an IRA intending to draw money out during retirement. This account works along with a company-sponsored Qualified Retirement Plan like a 401(k) or a Simplified Employee Pension (SEP) IRA that you may have available at a company. You can establish a traditional IRA or a Roth IRA in addition to any retirement account through an employer.

Roth IRA vs. Traditional IRA

Roth IRA

A Roth IRA is quite different from a traditional IRA in that no taxes are due when you take distributions. Instead, you pay taxes upfront on the contributions. In other words, you wouldn’t pay taxes on the growth or money you withdraw. With a traditional IRA, you pay taxes on the growth when you take distributions rather than when you contribute to your account. The primary difference between Roth IRAs and traditional IRAs is in a) the taxes paid on the money that goes into the accounts and b) the taxes paid on the money taken out. Both a traditional IRA and a Roth IRA grow tax-deferred, meaning taxes are not due each year on the growth.

In short, contributions to a Roth IRA are taxed beforehand and contributions to a traditional IRA are not. Since the money you contribute to a Roth IRA has already been taxed, you are not eligible to take a tax deduction on any money you put into the Roth. But, a Roth also allows you to reduce your taxable income in retirement.

Traditional IRA

With a Traditional IRA, you take a tax deduction (depending on your income) on the money you contribute to the IRA. Because your contributions were taxed before you put them into the Roth, that money is not taxed again when you withdraw it. Additionally, the potential earnings from the money in the Roth are also not taxed when you make withdrawals. If you think your situation in retirement will put you in a higher tax bracket, you may want to lessen the taxes you owe on money you withdraw from your retirement account. This would mean a Roth IRA would be better. However, with a Traditional IRA, your earnings and the money you contribute to the account are all taxed when you make withdrawals.

The following table compares the qualities of each type of IRA:

Roth IRATraditional IRA
Any potential earnings grow tax-freeAny potential earnings grow tax-deferred
Contributions are made with after-tax dollars and are not tax-deductibleContributions are made with pre-tax dollars
and are tax-deductible if you meet income requirements
Required minimum distributions (RMDs):
None. Roth IRAs do not require you to withdraw a minimum amount of money at a certain age.
Required minimum distributions (RMDs): Generally, you are required to withdraw a minimum amount of money starting at age 73.
Tax-free and penalty-free withdrawals of contributions at any time, for any reason.
Tax-free and penalty-free withdrawals of earnings if you meet IRS-qualified distribution requirements.
You pay taxes on any earnings and contributions when you make withdrawals.
Anyone 18 or older who has earned income within specific IRS income limits can contribute to a Roth IRA. In 2023, the upper limits for a partial contribution were: Less than $153,000 if single Less than $228,000 if married filing jointly
None. Anyone 18 or older with earned income can contribute to a traditional IRA. However, for contributions to be tax-deductible, specific income limits apply, as defined by the IRS.

Income Limits for Contributing to a Roth IRA 2023

There are rules for contributing to Roth IRAs. One rule is that the amount you can contribute to a Roth IRA is based on your Modified Adjusted Gross Income (MAGI). The IRS defines limits depending on your tax filing status. Income limits as well as contribution limits have changed from 2023 and 2024.

How to Choose Between a Roth IRA and a Traditional IRA

Whether you’re choosing between a traditional IRA and a Roth IRA for the first time, or you’re considering a roth conversions (i.e. converting your traditional IRA into a Roth IRA), it’s important to look at your financial situation today and project where you think you will be tomorrow.

Generally, if you think your tax bracket will be higher when you are taking withdrawals than it is when you are contributing, you may benefit from a Roth IRA. For example, if you are just starting your career or if you don’t want to take the tax break now but want it later, then the Roth IRA makes sense.

If you think your tax bracket will be lower when you are withdrawing money during retirement, then you may be better off using a Traditional IRA and paying taxes at that time.

Roth Conversions: Converting a Traditional IRA to a Roth IRA

Let’s take a closer look at roth conversions and their effect on your tax situation. It’s important to know that you will pay income tax on any funds that you convert from a traditional IRA to a Roth IRA in the year of the conversion. Here are some scenarios that could be advantageous for Roth conversions.

You think your tax bracket will be higher in retirement

In this scenario, paying taxes at your current rate is preferable to paying at a higher rate when you are retired and taking withdrawals. It’s possible to have higher taxes in retirement if you have accumulated significant savings in your retirement accounts, or have a consulting job that pays a high rate. It could make sense to convert all or a portion of funds from a traditional IRA to a Roth now and not in the future.

You want to maximize your estate for your heirs

If you don’t need to withdraw funds from your IRA during your lifetime, converting from a traditional IRA to a Roth IRA lets your savings continue to grow unaffected by RMDs. This can potentially leave more for If you want to grant your roth IRA as an inheritenace, you work closely with a tax advisor to do designate it to a loved one.

Your accounts are not diversified by tax treatment

If most of your retirement assets are in tax-deferred accounts, you may want to convert some assets to a Roth IRA. By converting to a Roth, you have assets that aren’t taxed when they are withdrawn, potentially allowing you to manage your tax brackets better and allow more personalized tax planning during retirement.

You have irregular income streams and income this year that is lower than usual

Let’s say that you own a business that generated a net operating loss from non-passive income. This could be an opportunity to convert some funds to a Roth IRA with a low tax impact. In this scenario, a Roth conversion is most advantageous for you.

How Income Can Affect Medicare Premiums

Roth conversions require you to understand the potential effect it has on your Medicare premiums. When funds are converted, the IRS sees this as income that has come out of the traditional IRA, which can raise your MAGI past a certain level, thereby increasing the premiums you pay for Medicare B and D. This increase is called an income-related monthly adjustment amount (IRMAA). If your conversion is accomplished at least two years before signing up for Medicare, you avoid the income increasing your income and triggering IRMAA. Your tax advisor can guide you on when you should convert without affecting Medicare premiums.

How Income Can Affect Social Security Benefits

If you or your spouse are currently drawing Social Security, be aware that a Roth conversion could increase the taxability of your Social Security. The taxation of your Social Security benefits is determined by the amount of your provisional income (also called combined income). There is a formula to calculate provisional income by adding together your Adjusted Gross Income (AGI), tax-exempt interest, and half of your Social Security benefits. Most people who have 85% of the benefit are subject to income tax; however, the taxable amount can be even lower if the provisional income is below certain thresholds. See your tax advisor for advice on your specific situation.

Contact Our Tax Planners for More Information on Roth Conversions

At Steward Ingram & Cooper, PLLC, we guide our clients on retirement and financial planning. If you want more information on Roth conversions, we encourage you to reach out to us today as make your retirment more comfortable. We serve areas throughout North Carolina including Raleigh, Wake Forest, Wilson, Apex, Durham, and Cary. To schedule a consultation, call us at  (919) 872-0866 or fill out the contact form below.

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