A Roth conversion moves money from a traditional IRA or 401(k) into a Roth IRA. You pay taxes on the converted amount upfront, but withdrawals grow tax-free forever and carry no required minimum distributions. The strategy works brilliantly for some people and wastes money for others.
Conversions make sense when your tax bracket is historically low. Early retirees who stopped working but haven't started claiming Social Security often sit in the 12 percent or 22 percent federal brackets. Converting during these years locks in a lower tax rate before required minimum distributions push you into higher brackets at 70-and-a-half. Self-employed people with volatile income can convert during low-income years. Anyone expecting to inherit a large sum or receive a bonus later benefits from converting now at a predictable rate.
Skip the conversion if you're currently in the top tax bracket and expect your situation to improve after claiming Social Security or selling a business. Converting at 37 percent federal rates defeats the purpose. People with substantial non-retirement assets also should hesitate. Roth conversions trigger the pro-rata rule if you hold any traditional, SEP, or SIMPLE IRA accounts. This rule taxes a portion of your converted amount based on your total pretax IRA balance, creating unexpected tax bills.
The "Medicare income thresholds" trap catches many people. Roth conversions count as provisional income for Medicare premium calculations. A conversion that saves $2,000 in future taxes might cost $4,000 more in Medicare Part B and Part D premiums over several years. High earners approaching Medicare age should run the numbers carefully.
Young investors with decades until retirement should rarely convert. The traditional IRA's pretax deduction lowers your current taxable income, which pays now. A Roth conversion only works if you expect higher future tax rates.