Opinion: Roth conversions: A compelling strategy for retirement

Myles Jackson

Everyone wants to implement high-impact strategies to build wealth and pay less in taxes. There is one strategy folks often overlook: Roth conversions.

With a Roth IRA, you benefit from both tax-free growth and withdrawals. If you follow all the rules, you never pay taxes on dollars you withdraw from a Roth IRA. Here are a few items to consider:

1. The maximum contribution in 2024 is $7,000.
2. There can be a 10% withdrawal penalty before age 59 and a half. After this, it’s all tax-free.
3. Your modified adjusted gross income must be less than $228,000 for married filing jointly.
4. As long as five years have passed since your first contribution, withdrawals of growth after age 59 and a half are not taxed or penalized.

Let’s walk through an example: You contribute $7,000 to a Roth IRA in 2024. You can withdraw $7,000 without incurring penalties or paying income taxes. If you withdraw on the growth, you pay a 10% penalty.

What if you and your spouse contribute $7,000 each for 25 years, and the market grows at 8% per year? You would hold approximately $640,000 in tax-free dollars.

Clearly, a Roth IRA can deliver meaningful results. From a tax planning perspective, it is a great place to stash cash. That said, contributing to a Roth IRA is a basic investing strategy.

Many wealthy individuals overlook Roth IRAs. Because of their high income, they assume they are no longer eligible to contribute to a Roth IRA. However, when it comes to conversions, the limits and rules change. Roth conversions allow everyone to take advantage of tax-free growth and income.

How does a Roth conversion work?

Traditional IRAs and 401(k)s are tax-deferred accounts. You receive a deduction today, then pay taxes when you withdraw. But you can convert dollars from these accounts into a Roth IRA, a tax-free account.

Let’s say you convert $100,000 from a traditional IRA into a Roth IRA. After five years and age 59 and a half, you may withdraw funds without taxes and penalties.

The $100,000 is going to be a taxable amount. You must be strategic. It is best to convert during periods when tax rates or your income are low.

What would a Roth conversion look like in real life?

Say from age 30 to 60, you contribute to a traditional 401(k). If your tax rate was 24%, you received a 24% tax deduction on every single dollar you contributed. For every $50,000 you contributed, you saved $12,000 in taxes.

Now, you are looking to retire. You steadily saved in your 401(k) over the years. It is probably a meaningful dollar amount ready for retirement. When you retire, you roll over the 401(k) into a traditional IRA. This is a direct rollover, so there is no tax impact.

You decide to convert $100,000 from a traditional IRA to a Roth IRA. You will pay taxes on this amount, but since you are no longer working full-time your tax rate is likely lower. Once converted, dollars you withdraw will not be taxed in the future.

What are some of the often overlooked benefits of a Roth conversion?

A traditional IRA will be subject to required minimum distributions. A Roth IRA will not. This means you have more control over your income, and in turn your taxes, during retirement.

Additionally, Roth IRAs allow your heirs to avoid taxes too. Even when received as an inheritance, Roth IRAs maintain their tax-free status.

So, what are the most important takeaways?

1. Roth IRAs allow tax-free withdrawals during retirement.
2. Generally, the goal is to get as much money into a Roth IRA as possible.
3. Converting from a traditional IRA to a Roth IRA is a great way to put more dollars in a tax-free account.
4. Roth conversions are most strategic and impactful during low-income years.
5. Roth IRAs can be tax and estate planning tools for retirement.

Myles Jackson is a wealth management adviser at SignalPoint Asset Management LLC in Springfield. He can be reached at mjackson@signalpointinvest.com.