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Pros and Cons of a Roth IRA Conversion

Posted by Busey Bank on Oct 18, 2022 8:15:00 AM
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Roth Individual Retirement Accounts (IRAs) can help round out your entire retirement picture. Because of this, many have the impression that having a Roth IRA is a good idea and, for some, this is the case. However, there are income limits on who can contribute. High income earners are not able to contribute directly to a Roth IRA on an annual basis because of the income limits. Because of this, many consider converting some or all of their Traditional IRA to a Roth IRA through a Roth IRA conversion. Under current law, a taxpayer may contribute to a Traditional IRA and then immediately process a conversion to their Roth IRA, which is called a back door Roth conversion. A back door Roth IRA conversion may be an opportunity for a high-income taxpayer to process an annual Roth IRA conversion.

A man and woman are sitting down, looking at some papers.

Could a Roth IRA conversion be a good idea?

Good question. However, the answer is not clear-cut as it depends on your long-term goals as well as current and future tax situation. There are a few questions to consider, including:

  • What are your long-term goals?
  • Are you wanting tax-free distributions in the future to manage potential taxable income?
  • Do you believe you may be in a higher tax bracket during retirement?
  • Do you need to reduce taxable retirement income to keep under the Medicare income limits?

One restriction to remember is that the conversion portion of the Roth IRA must stay in the Roth IRA for at least five years before pulling it out as a distribution. If a Roth IRA distribution includes part of the conversion amount, the taxpayer will have to pay an IRS penalty on the conversion portion.

Long-term goals

The main benefit of a Roth IRA is the distributions are tax-free under current tax law. This includes both the contribution portion and the growth portion of the Roth IRA. In other words, the distribution is tax-free no matter how much of the distribution is the contribution versus growth. Therefore, for many this is a good investment tool for their retirement years. Some may use distributions from their Roth IRA to supplement income needs to keep their taxable income lower to stay in a lower tax bracket or under the Medicare income limits.

A Roth IRA can be a powerful tool for legacy planning. Upon death, a Roth IRA can be passed to beneficiaries and their distributions would be tax-free. Many use this option to pass assets to their beneficiaries, so the beneficiaries do not need to pay tax on their distributions. This helps ensure this type of inheritance won’t be a tax burden on their beneficiaries.

Managing taxes now and in the future

Assuming all contributions were pre-tax, the conversion amount from a Traditional IRA to a Roth IRA is taxable. Because of this, a Roth conversion may not make sense. One calculation you may want to run is how long will it take for the return-on-investment on the conversion amount to recover the tax paid on the Roth IRA conversion. Is it two years, five years, 10 years? The return-on-investment period will depend on the taxpayer’s current tax bracket and how the Roth IRA is invested. Therefore, some may decide to convert their Traditional IRA to a Roth IRA over a period of time.

Unlike Traditional/Simplified Employee Pension (SEP)/SIMPLE IRAs, Roth IRAs do not have a Required Minimum Distribution (RMD) requirement. Therefore, if a person is going to have large RMDs once they enter RMD mode, they may consider Roth IRA conversions to reduce their requirement. This may lower future taxable income which is helpful if the taxpayer may be in a higher tax bracket later due to their RMD requirements.

Going forward

As you can see, converting to a Roth IRA is not an easy decision and is taxpayer specific. There are multiple factors to consider which is why it is important to involve your Wealth Advisor and Tax Preparer in this decision. They can help you determine how it may affect your long-term goals along with current and future tax considerations.

To learn more about Busey Wealth Management’s comprehensive suite of services, visit today.


This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.

This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.

This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.

Investment products and services through Busey Wealth Management are:
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Topics: Wealth

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