The Benefits of Converting Your IRA to a Roth IRA
Updated: Jan 3
The individual retirement account (IRA) is a smart move for forward-thinking American workers. It grows through investment and contribution and either provides immediate tax incentives or even better tax incentives upon retirement.
In fact, that’s the main difference between a traditional IRA and a Roth IRA: traditional IRAs let you avoid paying taxes on contributions, but Roth IRAs let you avoid paying taxes on withdrawals.
The traditional IRA has a chance to help you qualify for tax breaks in the short run because your contributions aren’t taxed once they enter your IRA, and you can deduct those contributions from your year-end tax liability. However, once you retire, you’ll be paying ordinary income taxes on withdrawals from your account in your post-retirement tax bracket.
The Roth IRA keeps your total tax liability low by taxing you in your current-year tax bracket on your contributions. While you can’t deduct those contributions on your year-end taxes, you won’t have to pay ANY tax on withdrawals after retirement.
For lots of Americans, that means there are some serious benefits to converting a traditional IRA to a Roth IRA.
Pay Tax Once at Your Current-Year Tax Rate
When converting your traditional IRA to a Roth IRA, you’ll have to pay the taxes on your contributions that you haven’t been paying until the time of your conversion. Luckily, because of the rules of a Roth IRA, that means you’ll only be paying at your current-year tax rate, which is likely to be lower than your retirement tax rate.
Once converted, you’ll continue to pay taxes on contributions at your current-year tax rate – but the conversion doesn’t require you to pay any more than you would have if you had held a Roth IRA since you started saving (assuming you haven’t moved tax brackets.)
No Tax on Withdrawals from Roth IRA after Retirement
Five years after your first contribution and age 59.5, withdrawals on your earnings are tax-free. If you’ve done some hefty saving that has put you in a higher tax bracket, it won’t matter for your withdrawals – you have no tax liability, so you get to keep that extra money you would otherwise be paying on each traditional IRA withdrawal in your higher tax bracket.
Flexibility on Withdrawals
With no tax liability, you can choose how much you withdraw each year to match your lifestyle. Beneficiaries of your IRA will also have no tax liability, so you can pass on some of your savings tax-free to help family members go to school or realize their dreams.
Roth IRAs give you a better chance to control your post-retirement income without worrying about post-tax withdrawal totals. Thanks to law changes that favor contributors, converting from a traditional IRA to a Roth IRA is generally simple and problem-free.
But be careful; don’t convert if you don’t have the capital to cover the taxes without dipping into your existing IRA. You’ll have to pay penalties and taxes on withdrawals from your traditional IRA if you plan to use the account to convert, which can lower your retirement savings quite a bit.
If you plan to convert, build separate savings that will cover your tax liability for conversion so you can pay it upfront. It’s the smoothest way to transition and ensure that you have flexible, bountiful income during retirement.
For individualized financial help rolling a traditional IRA to a Roth IRA, schedule an appointment with Americans for Life.