The last Tax Report delved into when it’s smart for seniors to convert taxable traditional IRAs to tax-free Roth IRAs. It prompted a flood of questions from Journal readers asking for more specifics, so we’ll address some of them.
Roth IRA conversions aren’t appropriate for all savers. But they often make sense for people with large traditional IRAs, which many have due to rollovers of traditional 401(k)s.
The key factor is the tax rate on the Roth IRA conversion amount vs. the tax rate on the funds at the time of withdrawal—tax arbitrage, if you will. If the rate on the conversion will be lower than the rate at withdrawal, conversion is often a smart move.
What about “opportunity cost,” the idea that dollars used to pay conversion tax lose out on investment growth? This isn’t an issue if tax rates are the same at contribution and withdrawal. While the conversion tax is paid earlier, it’s also smaller—and the deferred tax on the traditional IRA grows as the funds do.
Ed Slott, a Roth IRA advocate and CPA, offers a simplified example: Jane and Fred each have traditional IRAs with $100,000. These are invested identically and double over 10 years. The tax rate is 30%, so Jane pays $30,000 of tax to convert to a Roth IRA and has $70,000 to invest. At the end, she has $140,000 to withdraw tax-free.
Meanwhile, Fred doesn’t do a conversion, and his $100,000 pot grows to $200,000. But when he withdraws it, he owes $60,000 of tax. That leaves him with $140,000 after tax, the same as Jane.
What makes a Roth conversion smart or not is if the tax rates vary. If Jane’s tax rate on a Roth conversion is 20% but her tax rate at withdrawal is 30%, she’s likely a gainer. And if Fred’s tax rate on a conversion is 30% but his tax rate at withdrawal is 15%, he’s not.
Of course, evaluating a Roth conversion forces savers to guess the future. But sometimes that’s not hard—say, if a saver will be moving from high-tax state to a low- or no-tax state. The death of a spouse can also subject the survivor to a “widow’s penalty,” leaving him or her with a higher top rate as a single filer.
But savers using outside funds to pay the conversion tax in order to keep more dollars in the Roth IRA should consider their source. If the tax money is sitting in a low-interest account, using them to pay conversion tax could be smart. But if the saver will be selling stock and paying 15% on the capital gains, think more. Could selling a loser offset that tax?
Investment returns also matter, and that involves more guessing. The higher the returns are, the greater the Roth IRA’s advantage. In general, investors have done better by betting on long-term asset growth than against it.
You can, if you are the surviving spouse of the owner. This involves rolling funds from the inherited IRA into an IRA of your own and then doing a Roth conversion.
But most other heirs of traditional IRAs can’t do such conversions. And whether it’s a traditional or a Roth IRA, most heirs must drain the accounts within 10 years of the original owner’s death.
The five-year waiting period for tax-free Roth IRA withdrawals confuses many savers evaluating conversions. There are actually two five-year rules, but only one applies to people ages 59½ or older. The good news is that most older IRA owners won’t have trouble with it. Here’s a summary.
If a saver who is 59½ or older has at least one Roth IRA open for five years or more, there’s no five-year waiting period for tax-free withdrawals after a conversion.
If a saver 59½ or older has never had a Roth IRA and converts funds from a traditional IRA, things are a bit different. For the first five years after the conversion, the saver can take tax-free withdrawals of the converted amount but not the earnings on it. If the saver withdraws earnings before then, they’re taxable—but there’s no 10% penalty, as there is for savers younger than 59½.
What happens if a saver 59½ or older does a Roth conversion subject to the five-year rule and dies three years later? Then the heirs will qualify for fully tax-free withdrawals in two more years. Until then, withdrawals of the conversion amount are tax-free but withdrawals of earnings are taxable. Again, there’s no 10% penalty.
Note: For savers doing Roth conversions, the withdrawal rules are favorable because they assume that converted amounts come out before earnings. Only after the full conversion amount has been withdrawn are payouts considered earnings that might—or might not—be taxable.
No, you shouldn’t. Leaving traditional IRAs to charities is a tax trifecta because there’s no tax on dollars going in, no tax on growth, and no tax on dollars when they’re donated to the charity.
Converting some or all of your traditional IRA to a Roth IRA means paying tax when you don’t need to and shrinking the amount the charities receive.
Many savers who want to do Roth IRA conversions face this dilemma with the Medicare Part B and D surcharges for higher-earning taxpayers known as Irmaa.
Careful planning matters, because even a dollar more of income can trigger far higher Irmaa surcharges. It’s especially tricky because the surcharges are based on income from two years prior. So the 2025 Irmaa surcharges announced recently will use recipients’ reported income for 2023 and include a filer’s income from Roth conversions done in that year.
Some savers trying to avoid Irmaa use the most recent known Irmaa brackets to provide a margin of safety. Others look to websites—such as The Finance Buff—that estimate future Irmaa surcharges based on available but incomplete data.
