Should you consider converting your retirement savings into a Roth IRA?

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Both traditional IRAs and Roth IRAs are great ways to save for retirement, but the characteristics of the two are almost inherently opposite. With a traditional IRA, you can get a tax deduction on contributions, but you owe taxes on your future withdrawals. With a Roth IRA, you can’t deduct your contributions, but your qualifying withdrawals are tax-free.

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If you already have a traditional IRA, you may be able to convert it to a Roth IRA. However, whether this is a good choice depends on a number of factors, from your age to your tax bracket and income level. Here’s a look at the pros and cons of converting your retirement savings into a Roth IRA.

Consider your age

As you approach retirement age, converting to a Roth may not be in your best interest, especially if you’ve amassed a large nest egg. At this point, you’re probably in your peak earning years, which means you’re in your highest tax bracket. Converting to a Roth can put you in an even higher tax bracket, as you’ll have to pay taxes on the entire value of your account immediately. It will also take away your flexibility to create a tax-efficient withdrawal strategy in retirement.

On the other hand, if you are young, it can make sense to switch to a Roth for a variety of reasons. First, you’re probably in a lower tax bracket because your income hasn’t peaked yet and your retirement account size is also likely to be much smaller. By paying this lower tax now, you can expand your retirement account tax-free for most of your life, and your future retirement payouts are also tax-free.

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Consider your tax bracket

Your tax bracket is an important factor to consider when choosing between maintaining a traditional retirement account and converting to a Roth IRA. If you’re in a high tax bracket, the scales can tip in the direction of a traditional retirement account. For starters, you get a larger tax deduction on your contributions. You also avoid the high taxes you would owe if you switched to a Roth IRA, since your entire balance is fully taxable at normal income rates. If your tax rate is lower when you retire than it was when you worked – which is likely if you’re a high earner – then you may be in a worst-case scenario on conversion, as you’ll be paying higher taxes now rather than lower taxes after retirement to pay.

However, the opposite is also the case. If you’re in a low tax bracket now, you won’t pay as much tax on conversion, and you may find that your tax bracket is higher after you retire for a variety of reasons. For example, if you build up your retirement accounts, your income may even increase after retirement. It’s also entirely possible that the tax brackets themselves will increase in the future.

Look at your income

In addition to the tax situations created by your income level, there are also limitations on when you can contribute to a Roth IRA. For the 2022 tax year, joint applicants cannot contribute to a Roth IRA if their income exceeds $214,000. The limit for single people and heads of household is $144,000.

While there’s no income limit for Roth conversions, it doesn’t always make sense to convert to a Roth IRA if you can’t contribute in the future.

The final result

Many financial advisors recommend investors diversify their retirement accounts between traditional and Roth IRAs. This gives you the flexibility to make tax-deductible IRA contributions during your high-income years and make after-tax contributions to a Roth IRA when your income is lower. It also gives you the most opportunities to earn income after retirement, as you can make a variety of distributions in the most tax-efficient manner.

You can also avoid making the required minimum distributions on the assets you hold in a Roth IRA. However, because everyone’s tax and financial situation is different, you should consult with your tax and/or financial advisor as to whether or not you should convert your retirement savings into a Roth IRA.

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This article originally appeared on Should you consider converting retirement savings into a Roth IRA?

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