What Are Roth Conversions?

One of the tax-saving strategies getting a lot of attention in the news these days is the “Roth Conversion”. While sometimes portrayed as a technique used by the ultra-wealthy to shield their assets from taxation, the strategy should be considered even by us mere mortals as the potential benefits can be surprising.

The heart of the strategy is attempting to predict whether your effective income tax rate will be lower now or in the future. Using a combination of “traditional” retirement plans or accounts – such as 401(k)s or IRAs – and Roth IRAs allows the account owner the opportunity to decide to pay taxes when the rates are potentially more favorable.

Assets contributed to traditional retirement plans or IRAs are made before taxes and accrue tax-free. Taxes are only paid on the assets when distributed. You cannot defer taxation in perpetuity, however, as you are required to begin making distributions (and paying taxes) from your traditional account(s) starting at age 72.

By contrast, Roth accounts receive contributions that have already been taxed. The assets within will grow and be distributed tax-free, assuming they have been invested within the account for more than 5 years. Roth accounts allow you to effectively “lock in” the tax rate at the time of a contribution.

The decision about whether it is best to contribute to a traditional or a Roth account largely comes down to when you think your tax rate will be lower. This depends in large part on what you predict your income level will be during the current and in future years relative to the tax brackets which exist today, but also on what you anticipate the tax brackets of the future to be. For instance, current effective tax rates being the lowest they have been in decades coupled with massive deficit spending make it difficult to foresee future tax rates being much lower than they are today.

But what do we mean by a “Roth Conversion”? Often, we have been good savers and deferred taxes for years and have large Traditional retirement plan balances. Now you have the ability to convert some or all of that balance into a Roth account, thereby paying taxes now in order to avoid doing so later on when the rates might be higher. Conversions are particularly attractive options during periods of time where your income is relatively low, such as after retirement but before age 72, when required minimum distributions from traditional retirement plans kick in. The more you can reduce your traditional account balances before age 72, the lower the tax bill from the required distributions will be.

As always, please reach out to your Armor team if you would like to learn more about Roth conversions and if they may be a good idea for you!


Nothing contained in this publication is intended to constitute legal, tax, securities or investment advice, nor an opinion concerning the appropriateness of any investment, nor a solicitation of any type and does not guarantee future results. The information contained in this publication should not be acted upon without specific legal, tax and investment advice from a licensed professional. Past results are not indicative of future performance.