Buyer Beware: Should You Convert Your Pre-Tax IRA to a Roth IRA in Retirement?

Many financial publications highlight the benefits for retirees of converting a pre-tax IRA to a Roth IRA for tax-free accumulation. While this can be a beneficial strategy, there are several unpleasant side effects to be aware of.

Keep reading or watch this video about IRA conversions in retirement

Considerations for Retirees Who Want to Convert a Pre-Tax IRA to a Roth IRA

Higher Medicare Premiums

One potential downside is that the taxable income generated from a Roth conversion could increase your Medicare Part B and Part D premiums. These premiums are based on your modified adjusted gross income (MAGI) from two years prior and can range from $174 to over $400 per month, depending on your income.

A large Roth conversion could push you into a higher income tier, resulting in higher Medicare costs.

Tax Rates for Beneficiaries

While a Roth conversion allows you to pay taxes upfront at your current rate and enjoy tax-free withdrawals in retirement, your beneficiaries may be in a lower tax bracket than you. In this case, leaving the funds in a traditional IRA might make more sense, as well as letting your heirs pay taxes on withdrawals at their potentially lower rates.

Required Minimum Distributions Cannot Be Converted

You cannot convert required minimum distributions (RMDs) from a traditional IRA to a Roth IRA. RMDs must be taken and will be subject to ordinary income tax. This limits the amount you can convert, especially after age 72, when RMDs become mandatory.

Other Considerations

• The 5-year rule: Earnings from a Roth conversion cannot be withdrawn tax-free until five years after the conversion.
• Tax bracket changes: A Roth conversion may not make sense if you expect to be in a lower tax bracket in retirement since you'll pay taxes at a higher rate now.
• Estate plans: If you plan to leave your IRA to charity, a Roth conversion is unnecessary since qualified charitable distributions from a traditional IRA are tax-free.

Interested in learning more about Roth IRAs? Peruse these relevant blogs:

• Breaking Down Retirement Plans for Physicians and Dentists
• Why Doctors Should Consider a Backdoor Roth IRA for Retirement Saving
• How to Report Your Backdoor Roth IRA on Your Taxes
• When Is the Best Time to Fund Your Roth IRA?
• Demystifying The Mega Backdoor Roth?

The Bottom Line

While Roth conversions can be beneficial, it's crucial to carefully evaluate your specific situation, including future tax rates, Medicare costs, estate plans, and income needs, before deciding if and when to convert funds.

Working with a qualified financial advisor can help ensure you make the most tax-efficient decision. If you're considering whether a Roth conversion is right for you, please get in touch with one of our financial planners.

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