Today’s article comes from a question for Money Girl listener Nancy P., who says:

“I recently discovered your podcast and really enjoy it! I’m 60, single, have an annual income of $84,000, and want to retire at 63. I participate in my 401(k), which has a $900,000 balance, and have a Roth IRA. Should I do annual Roth conversions up to the maximum annual amount–and how would that affect my taxes?”

Thanks for your question, Nancy! Knowing if or when you should do Roth conversions is an excellent topic we’ll cover in this post. I’ll review the Roth conversion rules, how they may fit your retirement goals, and tax consequences to carefully consider.

What is a Roth conversion?

Doing a Roth conversion means withdrawing and moving funds from a pre-tax source, such as a traditional IRA or 401(k), to an after-tax Roth. Since traditional retirement funds typically haven’t been taxed, moving them to a Roth means you’ll owe ordinary income taxes in the year you make a conversion.

Having more money in a Roth is terrific because the account growth is never taxed, if you follow some basic rules, allowing you to have a source of tax-free income in retirement. In addition, unlike traditional retirement accounts, Roth funds are never subject to required minimum distributions (RMDs). 

Nancy mentioned being restricted by an annual Roth conversion limit. But I want to clarify that there are no annual limits for Roth conversions–only for new contributions. You can convert as much pre-tax money to a Roth annually as you like. Also, unlike Roth IRA contributions, Roth conversions have no income limit. 

Laura covers three legit ways to have a Roth IRA–even if you’re technically ineligible because you earn too much–and why their tax-free benefits are so powerful for young owners and retirees. Listen to episode 768 in the player below.

What tax do you pay on Roth conversions?

As I mentioned, you can convert as much as you like from traditional to Roth retirement accounts each year, and the IRS will happily take your income taxes. For example, if you want to convert $50,000 from your traditional IRA to your Roth IRA, your annual taxable income increases by $50,000, significantly increasing your tax liability. 

Nancy mentioned that she’s single with $84,000 of income, which puts her in the 22% tax bracket for 2024. But amounts over $100,525 get taxed at 24%, the next highest tax bracket. Therefore adding $50,000 of taxable income means $33,475 ($84,000 + $50,000 – $100,525) of her income would be taxed at 24%, instead of 22%.

To avoid having a portion of her income taxed at a higher rate, Nancy could be strategic and only convert enough to stay in the lowest possible tax bracket. For instance, doing a maximum Roth conversion of $16,000 means her total income for the year would be $100,000 ($84,000 + $16,000), keeping her below the $100,525 cutoff for the 22% tax bracket. 

What are the pros and cons of Roth conversions?

While doing a Roth conversion means voluntarily increasing your taxable income, the primary benefit is paying a lower tax rate now versus a potentially higher rate later. Or to create more tax-free growth and income for your retirement. 

However the downside is that you should have enough income or savings to pay the additional tax. While you can hold some funds back from a Roth conversion to cover your taxes, it’s better to use savings outside your retirement account. That allows you to put as much as possible into your Roth so it grows tax-free.

Also, remember that if you’re younger than 59.5, holding back a retirement withdrawal to pay taxes on a Roth conversion means it would be subject to a 10% early withdrawal penalty.

READ ALSO: Is it better to have a traditional or Roth IRA?

When should you do a Roth conversion?

Since Roth conversions increase your taxable income, the best time to do them is in any year your income dips. Many people do conversions in the so-called “gap” years after they retire and earn less but before they claim Social Security benefits or their RMDs begin at 72 or 73. 

You can claim Social Security as early as 62 and as late as 70. Nancy didn’t mention when she wants to begin retirement benefits, but she said that wants to retire at 63. Let’s say she plans to start Social Security at her full retirement age of 67. 

In that case, her income will go down significantly at age 63 when she stops working. Even if she wants to work part time for a year or two, she’ll likely earn less than she does today. Therefore, from age 63 to 73, she’ll have the most control over the amount and source of her income, making it the perfect time for Roth conversions.

Right now, Nancy is likely at the peak of her career, and adding Roth conversion income to her earned income means it could result in the highest tax she’s ever paid. Instead of converting now, when you already have significant income, waiting until after retirement when your wages are lower or zero may be best.  

Who should do Roth conversions?

Here are some scenarios when converting funds in a traditional retirement account to a Roth could be wise:

• You believe your tax rate is lower now than it will be in retirement.
• You want to leave tax-free money to your heirs.
• You have most or all of your retirement funds in tax-deferred accounts.
• You have lower wages or business income.
• You have retired but don’t receive Social Security or RMD income.
• You have enough savings or funds in a brokerage account to pay conversion taxes.

If you decide that a Roth conversion is right for you, remember that you can do multiple conversions over several years to limit the negative tax consequences. The idea is to convert just enough to stay under the next highest tax bracket. 

For 2024, income of $190,000 is the top of the 24% bracket for singles. If Nancy wanted to make Roth conversions that total $450,000, she could break it into three conversions of $150,000 annually when she’s 64, 65, and 66. That’s when her income is likely to drop but before her full Social Security retirement age.

Another strategy Nancy may have to get more money in a Roth is called a mega backdoor Roth conversion, which I cover in detail in Money Girl episode 835. In short, doing a mega backdoor requires you to make after-tax contributions to a 401(k) and then convert them to your Roth 401(k) or to a Roth IRA. However, it depends on what your workplace retirement plan allows. Not every 401(k) has a Roth or gives participants the option to make rollovers inside or outside your plan.

Everyone’s situation and retirement plans are different, so you should seek guidance from your benefits department or a financial advisor because you can’t reverse Roth conversions if you change your mind. Plus, as I mentioned, it’s wise to have enough cash to pay federal and any applicable state taxes on a Roth conversion, instead of using money from your retirement account.