Roth Conversion
The process of moving funds from a traditional pre-tax retirement account to a Roth IRA, paying income tax on the converted amount.
What is Roth Conversion?
A Roth conversion is the transfer of funds from a traditional IRA, 401(k), or other pre-tax retirement account into a Roth IRA. The converted amount is added to taxable income in the year of conversion and taxed at ordinary income rates. In exchange, the money grows tax-free in the Roth account and qualified withdrawals in retirement are tax-free. Roth conversions are most beneficial when: current tax rates are lower than expected future rates; the account holder has a long time horizon for tax-free growth; or they want to reduce future Required Minimum Distributions (RMDs). Conversions can be done in full or in partial amounts — partial conversions allow taxpayers to fill up lower tax brackets strategically.
Example
A 55-year-old has $500,000 in a traditional IRA and expects to be in a higher tax bracket in retirement. In a year with lower income, they convert $50,000 to a Roth IRA. Adding $50,000 to income pushes them into the 22% bracket only partially, costing $11,000 in taxes now. The $50,000 then grows tax-free for 15+ years — a worthwhile trade if the tax rate in retirement would have been 24%+.