Do you want to save more of your hard-earned money and boost your retirement savings?
A Roth conversion might be the answer. By transferring your money from a regular IRA to a Roth IRA, you have the potential to grow your money and enjoy tax-free withdrawals.
But does a Roth conversion fit into your financial planning strategy? At Deerfield Financial Advisors, we want you to have the right information at your fingertips at all times so you can make informed financial decisions.
Let’s start with a simple definition of Roth conversions.
What Is a Roth Conversion?
A Roth conversion is when you transfer funds from a standard IRA or other comparable retirement plan—such as a 401(k)—into a Roth IRA. The main distinction is that traditional IRA contributions may be tax-deductible, but retirement withdrawals are subject to income tax.
On the other hand, contributions to Roth IRAs are always subject to up-front taxes, but eligible withdrawals made during retirement are tax-free. That means you can pay taxes now and take advantage of tax-free growth and withdrawals in the future.
Taking advantage of Roth conversion benefits is a calculated move that may have tax savings advantages, but before you make a final decision, you should think about your long-term objectives, current income tax bracket, income sources in retirement, and other wealth management related considerations.
Traditional IRA vs. Roth IRA
Let’s take a summarized look at the differences between a traditional IRA and a Roth IRA. The main difference between the two types of IRAs hinges on whether you think your tax rate might be higher or lower in retirement. But there are other important considerations.
| Traditional IRA | Roth IRA | |
| Annual contribution limit | 2024: $7,000 ($8,000 if age 50 or older) | |
| Income Eligibility | Eligibility for deducting contributions can be gradually phased out depending on the taxpayer’s income and access to an employer retirement plan. | Eligibility to contribute is gradually phased out for high-income earners. |
| Tax benefits | Deductible contributions lower taxable income in the year they are made. Retirement payouts are subject to ordinary income taxation. | Contributions have no immediate tax benefits, but retirement distributions are tax-free. |
| Early withdrawal | Distributions from a traditional IRA made before the age of 59½ are subject to taxes and a 10% penalty unless you qualify for an exception. This is true for both contributions and returns on investments. | Contributions to Roth IRAs can be taken out whenever you want, but unless you qualify for an exception, any earnings released before the age of 59½ may be subject to income taxes and a 10% penalty. |
| Retirement distributions | After you reach a certain age, minimum distributions are required. Previously, that age was 72; it went up to age 73 in 2023. | No required minimum distributions. |
Tax Bracket Considerations for Roth Conversions
When you transfer your money from a traditional IRA to a Roth IRA, you’re assuming that the tax benefits of the Roth IRA are superior to a traditional IRA.
But what’s the right way to determine if that’s actually true? Consider your current tax bracket. Now think about which tax bracket you’ll be in when you retire.
Ask yourself if you’d rather pay taxes at today’s rate or at your retirement rate. Answering these questions is the easiest way to determine if a Roth IRA or traditional IRA is right for your specific financial situation.
Income Eligibility Caps
There are income caps associated with who is or is not able to contribute to an IRA. Here’s a summary of Roth IRA eligibility based on your modified gross income:
Single Tax Filing Status:
- $146,000 or less: You can contribute the maximum limit.
- $137,500–$159,500 range: You can contribute a reduced amount.
- Over $161,000: Not eligible
Married Tax Filing Status:
- $230,000 or less: You can contribute the maximum limit.
- $231,000–$239,000 range: You can contribute a reduced amount.
- Over $240,000: Not eligible
What if you see yourself in a higher tax bracket in the future but you’re not eligible to contribute to a Roth IRA? Is there a way to still take advantage of the Roth account tax benefit? At first glance, it may seem as if you’re out of luck. But in reality, there are no income limits associated with a Roth IRA conversion.
Backdoor Roth IRA
A backdoor Roth IRA offers a strategic solution for individuals surpassing the income thresholds for a traditional Roth IRA yet seeking its tax advantages. This method involves contributing funds to a traditional IRA and utilizing the Roth IRA conversion, which has no income restrictions.
Throughout this process, there is a requirement to pay taxes on the contributed amounts and any accrued gains. However, this strategy allows your investments to grow tax-free, aligning with your long-term financial goals. Ultimately, upon retirement, you can withdraw funds without facing tax consequences.
We recommend conducting a thorough review of your retirement accounts, assessing current tax brackets, and considering future financial expectations to determine the viability of this approach.
Are You a Good Fit for a Roth Conversion?
A Roth conversion might be right for you if you currently have a traditional IRA but think you’ll eventually find yourself in a higher tax bracket when it comes time to take money out.
Don’t forget that taxes aren’t deducted from traditional IRA contributions. That means that if/when you convert to a Roth IRA, you’ll have to pay taxes on funds coming out of the traditional IRA before they’re transferred to the new Roth IRA.
Once the taxes are paid, the conversion can happen. No matter how far up the tax bracket ladder you go, your money can now grow tax-free.
Reach Out
If you have questions about Roth conversion benefits or if I can help in any way, call (317) 644-7701 or email mroop@deerfieldfa.com.
About Matt
Matt Roop is Wealth Manager and Shareholder at Deerfield Financial Advisors, a fee-only financial services and wealth management firm with offices in Indianapolis and Chicago. In his role, Matt acts as a personal “chief financial officer” for his clients, overseeing every facet of their financial landscapes, orchestrating strategies to grow their wealth, and enhancing their financial clarity. Catering to the distinct needs of lawyers, engineers, and business owners, he empowers them to embrace their passions and lead their optimal lives. Matt conveys a depth of experience and a calm demeanor that clients find reassuring and soothing, and he loves providing peace and confidence around their financial future.
Matt received a Bachelor of Science from Indiana University and a Master of Business Administration (MBA) from George Washington University. He is a NAPFA Registered Financial Advisor and holds the CERTIFIED FINANCIAL PLANNER™ and Certified Exit Planning Advisor (CEPA) designations. Committed to staying at the forefront of his field, he is actively involved with the Exit Planning Institute, National Association of Personal Financial Advisors, and the Estate Planning Council of Indianapolis. Since 1997, Matt has been involved in the investment and wealth management realm, with experience at Charles Schwab & Co., Inc., as well as a boutique Indianapolis-based independent advisory firm and a brief stint at his family’s closely held business.
Outside the professional realm, Matt serves his Indianapolis community by volunteering for Meals on Wheels of Hamilton County and is on the Executive Leadership Team for the Indiana Alzheimer’s Association’s Walk to End Alzheimer’s. He is dedicated to financial stewardship and continuous growth, with an unyielding commitment to enhancing the lives of both his clients and his community. Matt and his wife, Kimberly, reside in Carmel, IN, with their four children, who are all pursuing their college dreams. When he’s not working, he enjoys traveling, reading, and spending time at his lake house in southern Indiana with family. To learn more about Matt, connect with him on LinkedIn.
