Pros and Cons of Roth Conversion: What You Need to Know

Converting a traditional retirement account to a Roth IRA can be appealing, but it comes with important considerations. While tax-free withdrawals in retirement are attractive, the upfront tax cost and other factors require careful evaluation.

Benefits of Roth Conversion

A Roth conversion provides flexibility in managing taxable income during retirement, especially for those expecting to be in a higher tax bracket later. Since Roth IRAs do not have required minimum distributions (RMDs), account holders can let their investments grow tax-free indefinitely, potentially increasing overall wealth. This is particularly useful for individuals who do not need immediate access to their retirement funds and want to leave assets to heirs in a tax-efficient way.

Unlike traditional IRAs, which require beneficiaries to take taxable distributions, inherited Roth IRAs allow tax-free withdrawals if the account has been open for at least five years. This can ease the tax burden on heirs, particularly those in higher tax brackets. Because Roth IRAs are not subject to RMDs during the original owner’s lifetime, more assets can be passed down, maximizing intergenerational wealth transfer.

A Roth conversion can also hedge against future tax increases. With federal tax brackets set to expire in 2026 under the Tax Cuts and Jobs Act, many individuals may face higher rates. Converting now locks in today’s tax rates, potentially reducing lifetime tax liability. Those with a mix of pre-tax and after-tax retirement accounts can use this strategy to better control taxable income in retirement.

Drawbacks of Roth Conversion

The biggest drawback of a Roth conversion is the immediate tax liability. The converted amount is treated as ordinary income in the year of conversion, which can push taxpayers into a higher bracket. This can also increase taxes on Social Security benefits or raise Medicare premiums due to the Income-Related Monthly Adjustment Amount (IRMAA). For example, in 2024, single filers with modified adjusted gross income (MAGI) over $103,000 and married couples above $206,000 face higher Medicare Part B and D premiums.

Timing is another challenge. If markets are at a peak when the conversion occurs, investors may pay taxes on a higher account value, only to see their portfolio decline in a downturn. This risk is especially relevant for those converting large amounts in a single year rather than spreading conversions over multiple years. Market volatility can also affect the break-even point—the time it takes for tax-free growth to offset the upfront tax cost—potentially making the conversion less beneficial than expected.

Liquidity constraints are another factor. The taxes owed on a conversion should ideally be paid from non-retirement funds to maximize tax-free growth. If an investor withdraws funds from the retirement account to cover taxes, they reduce the amount that can compound over time. Worse, if they are under 59½, the IRS imposes a 10% early withdrawal penalty on any distributions used to pay the tax bill.

Tax Implications of Roth Conversion

The tax consequences of a Roth conversion depend on the converted amount and the taxpayer’s overall financial situation. Since converted funds are treated as ordinary income, the tax liability varies based on federal and state tax rates. In 2024, federal income tax brackets range from 10% to 37%, meaning a large conversion could push an individual into a higher marginal bracket. This impact is amplified in states with their own income taxes, such as California, where rates can reach 13.3%.

For high-income earners, the Alternative Minimum Tax (AMT) is another factor. In 2024, the AMT exemption is $85,700 for single filers and $133,300 for married couples filing jointly. A substantial Roth conversion could reduce or eliminate this exemption, subjecting more income to the AMT calculation. Additionally, those who previously made nondeductible contributions to a traditional IRA must account for the pro-rata rule under IRS Form 8606, which requires that conversions be taxed proportionally based on pre-tax and after-tax contributions across all traditional IRAs.

Estate planning considerations may also play a role. While Roth IRAs provide tax-free distributions for beneficiaries, the conversion itself can reduce the value of an estate subject to federal estate tax. The federal estate tax exemption is $13.61 million per individual in 2024, but this threshold is set to drop in 2026 when provisions of the Tax Cuts and Jobs Act expire. High-net-worth individuals might use Roth conversions to reduce taxable estate value. Additionally, for those leaving assets to heirs in states with inheritance taxes, such as Pennsylvania or Nebraska, a Roth conversion shifts the tax burden to the original account holder rather than the beneficiary.

Eligibility Criteria for Roth Conversion

Anyone with a traditional IRA, SEP IRA, or SIMPLE IRA that has met the two-year participation requirement can convert to a Roth IRA, as there are no income limits restricting eligibility. This allows high earners, who are otherwise barred from making direct Roth IRA contributions due to income phase-outs—$161,000 for single filers and $240,000 for married couples filing jointly in 2024—to use a backdoor Roth strategy.

Employer-sponsored retirement plans such as 401(k)s and 403(b)s have additional restrictions, requiring either a triggering event like separation from service or a plan provision permitting in-service rollovers. For those with assets in a designated Roth account within an employer plan, direct rollovers to a Roth IRA avoid taxation, but pre-tax contributions in a traditional plan are subject to income tax upon conversion. The IRS mandates that funds be transferred within 60 days if taken as a distribution to prevent penalties, making direct trustee-to-trustee transfers the preferred method. Additionally, individuals must ensure that any required minimum distributions (RMDs) for the year have been satisfied before converting, as RMDs themselves are ineligible for conversion.

Strategies for Roth Conversion

Executing a Roth conversion effectively requires careful planning to minimize tax liability and maximize long-term benefits. The timing, amount converted, and funding source for taxes all influence the financial impact.

One approach is to implement a multi-year conversion strategy, spreading the taxable income over several years to avoid pushing into higher tax brackets. This is particularly useful for retirees in lower-income years before claiming Social Security or those with large traditional IRA balances. For example, an individual with a $500,000 traditional IRA might convert $50,000 annually over ten years rather than converting the entire amount in one year, reducing the risk of excessive tax exposure. Monitoring tax law changes, such as the scheduled expiration of the Tax Cuts and Jobs Act in 2026, can help determine the most tax-efficient years for conversion.

Another strategy involves using tax deductions and credits to offset conversion taxes. Charitable-minded investors can pair Roth conversions with qualified charitable distributions (QCDs) from traditional IRAs, which allow tax-free donations of up to $105,000 in 2024 for individuals over 70½. Business owners may also leverage deductions from contributions to retirement plans like SEP IRAs or solo 401(k)s to counterbalance the taxable income generated by a conversion. Additionally, those with capital losses from investments can use them to offset gains, reducing overall taxable income in the conversion year.

Alternatives to Roth Conversion

While Roth conversions offer advantages, they are not the only way to achieve tax-efficient retirement planning.

One alternative is contributing directly to a Roth IRA or Roth 401(k) if eligible. Unlike conversions, direct contributions are not subject to immediate taxation and allow for gradual tax-free growth. High earners who exceed Roth IRA income limits can use a backdoor Roth contribution by making nondeductible traditional IRA contributions and then converting them, avoiding pro-rata complications if they have no other pre-tax IRA balances. Employer-sponsored Roth 401(k) plans also offer higher contribution limits—$23,000 in 2024, plus a $7,500 catch-up for those 50 and older—providing a tax-free growth vehicle without requiring a conversion.

Another option is using taxable brokerage accounts, which offer flexibility in withdrawals without early distribution penalties or RMDs. While investment earnings are subject to capital gains tax, long-term capital gains rates are often lower than ordinary income tax rates. Tax-efficient investing strategies, such as holding municipal bonds or index funds with low turnover, can further minimize tax liability while maintaining liquidity. Additionally, health savings accounts (HSAs) provide another tax-advantaged savings vehicle, offering deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses.