As we head full speed into the end of the year, there’s a lot to think about. Between visits with family and friends, holiday shopping, and celebrations, it can be hard to make time for anything else. There is, however, one important year-end process we highly encourage you to consider this time of year. That’s – you guessed it – year-end tax planning, including Roth Conversions.
It is all too easy to put off worrying about taxes when the April 15th filing deadline feels so far away. But we at Pathview know from experience that the ideal time to start thinking about your taxes is actually prior to year-end. As a result, this gives you the opportunity to make moves that can help to minimize your tax liability. In this article, we’ll be taking a closer look at one of these strategic tax planning opportunities: Roth conversions.
The 4 Ws of Roth Conversions
Before we get too far into the specifics, it’s important to start with a solid understanding of what a Roth conversion is. Moreover, you should know how it works, and why it may or may not be beneficial for you.
Roth conversions – What are they?
Essentially, a Roth conversion is the act of repositioning your IRA or other traditional retirement assets to a Roth IRA. You can do this in a few different ways.ays.
First, you can take a cash distribution from your IRA. You then deposit those funds into a Roth IRA. This is a 60‑day rollover. You must deposit the funds into the Roth IRA within 60 days. If you do not deposit the funds within this timeframe and are under age 59 ½, you will be subject to a 10% penalty in addition to the regular income taxes on the amount withdrawn from the IRA.
You can also make a trustee‑to‑trustee transfer directly from your IRA to your Roth IRA. This route can allow for less risk and potential for error when making the conversion. This is especially true if both accounts are with the same institution.
Roth conversions – Why are they beneficial?
IRAs and other traditional retirement accounts use pre‑tax dollars, so the initial contribution is tax‑deductible. This provides a tax break in the year you contribute. However, you pay taxes on the earnings when you withdraw the funds. This typically happens at age 59 ½.
Additionally, traditional IRAs are subject to Required Minimum Distributions (RMDs), the IRS’s way of getting back some of that tax-deferred money. This money has been growing in your account over a period of many years. At age 73, required withdrawals begin and are taxed as ordinary income. For those with large IRAs, this can significantly increase your tax bill.
This is where a Roth conversion could potentially come in handy. Traditional IRAs use pre‑tax dollars, while Roth IRAs use after‑tax dollars. This means that you pay the taxes on the contribution up front. As a result, the money grows tax-free for as long as you have the account. Withdrawals from a Roth IRA will also be tax-free, provided you meet certain requirements. Roth IRAs also are not subject to RMDs. Therefore, you can determine when and how much you withdraw per year in retirement.
There are certain rules in place regarding eligibility to contribute to a Roth IRA outright. Your modified adjusted gross income (MAGI) determines eligibility. In 2023, single filers can contribute the full amount to a Roth IRA if their MAGI is under $138,000. Similarly, married couples filing jointly can do so if their MAGI is under $218,000. If MAGI exceeds $153,000 for single filers or $228,000 for married couples filing jointly, you cannot make contributions.
There are, however, no income restrictions on Roth conversions. This means that even if your income is over the limit to make a direct contribution, you are still able to convert assets from your traditional IRA. Therefore, this allows you to take advantage of the benefit of tax-free growth.
Roth conversions – Who should be doing them?
As I noted above, there are no income limits or restrictions on who is able to convert their IRA assets to Roth. That said, a Roth conversion may or may not make sense in certain situations. How do you know which applies to you? Here are some questions you can ask yourself.
- Do I think my tax bracket will be higher in future years and/or in retirement? If the answer to this question is yes, a Roth conversion might make sense for you. Because you pay taxes on the initial contribution, it often makes sense to pay them now—while you’re in a lower tax bracket. This is better than paying them later, when required IRA withdrawals begin.
- Do I want to leave more money for my heirs? If you don’t have a need for the funds in your IRA, and plan to leave these to your heirs in the event something should happen to you, it might be a good idea to convert some of these assets to Roth. This means that when your heirs inherit the account and withdraw the funds, the withdrawals will be tax-free so long as the account is more than 5 years old.
- How soon will I need the funds in my IRA? As I alluded to above, withdrawals of earnings from a Roth IRA will be taxed at your normal income rate if the funds are taken from the account while it is less than 5 years old. So, if you are retired or are nearing retirement and will need access to these funds sooner, a Roth conversion may not be the best option for you.
These are just a few examples of questions you may take into consideration when deciding whether to proceed with a Roth conversion. As always, we recommend working with a qualified tax preparer on your year-end tax planning to ensure that all aspects of your unique situation are accounted for. This is important before proceeding with any strategic year-end tax planning opportunities.
Roth conversions – When should you convert?
The technical answer to this question is anytime. There are no limits on the number of Roth conversions you can do in a year. That being said, as with the question above, the true answer is a bit more nuanced than that.
Because your initial contribution into the Roth IRA will be taxed at your normal income tax rate, you’ll want to make sure you do this at a time when you have funds available to pay the resulting tax bill. You may also want to evaluate your income and overall investment performance. This can help you determine if a Roth conversion makes sense.
Special note for business owners and the self-employed: In years when your income is lower than what is typical, a Roth conversion could be a smart move for you. Since this could have a lower impact on your overall tax burden for the year, it is often worth considering.
Year-end is a great time to look at the potential for Roth conversions. As the year is coming to a close, it is generally easier to estimate tax liability. You can also determine the ideal amount to convert.
In Conclusion
Year-end tax planning is a complex process involving the consideration of multiple factors to determine which tax-smart moves may help to lower your overall tax liability. Roth conversions are just one example of these strategic opportunities. As a result, they could really help with your long-term tax planning.
To learn more about year-end tax planning and which strategies may be a good fit for your unique financial situation, please feel free to contact us.
A Roth conversion moves assets from a traditional IRA or other pre‑tax retirement account into a Roth IRA. You pay ordinary income tax on the amount converted in the year of the conversion, and the assets then grow tax‑free inside the Roth IRA if you meet IRS requirements.
Year‑end tax planning allows individuals to estimate their annual income and tax bracket with greater accuracy. This timing helps determine whether converting retirement assets before December 31 may align with broader tax‑planning goals, such as managing future required minimum distributions or improving long‑term tax flexibility.
No income limits apply to Roth conversions. While the IRS restricts who can make direct Roth IRA contributions based on modified adjusted gross income (MAGI), anyone can convert eligible traditional retirement assets to a Roth IRA regardless of income level.
Roth IRAs do not require lifetime RMDs for the original account owner. Converting assets from a traditional IRA to a Roth IRA can reduce the size of future RMDs, which may lower taxable income later in retirement. This change can also influence Medicare premiums and Social Security taxation.
Roth conversions often receive consideration during years of lower taxable income, periods between retirement and RMD age, or years with market declines that reduce account values. Business owners and self‑employed individuals may also evaluate Roth conversions in years when income falls below their historical average.
The IRS applies a five‑year holding rule to Roth conversions. Withdrawals of converted amounts avoid penalties after five years, while withdrawals of earnings also require the account holder to meet age and other IRS conditions. Timing matters when evaluating whether a conversion aligns with near‑term cash‑flow needs.
Roth conversions represent one component of year‑end tax planning. Effective planning evaluates conversions alongside other factors such as tax brackets, investment income, deductions, charitable giving, and long‑term estate considerations. Coordinating these elements helps ensure decisions reflect the full financial picture.