Why You May Want To Convert An IRA To A Roth IRA (And The Best Age To Do It)

Roth IRA accounts and their traditional IRA counterparts each form an important part of a modern-day worker's plan to eventually retire. The individual retirement account, or IRA, is only a recent development, coming into being with the 1974 Employee Retirement Income Security Act (ERISA). The Roth IRA is even younger, established as part of the Taxpayer Relief Act of 1997. For anyone who isn't familiar with the difference, it's all about tax incentives and how you might strategize lowering your overall tax burden heading into and throughout retirement.

The traditional IRA is funded with pretax dollars, meaning your investment can grow before taxes are imposed on their value. Then, as you strategize your distributions, the money is treated similarly to the income you've earned throughout your working life. A Roth IRA, on the other hand uses dollars that are already taxed. The IRS treats this after-tax money as if it were yours the entire time, sitting in a bank account somewhere.

That means that whether your Roth grows by a single dollar or by $1 million over the course of its lifetime, the entire sum of money grows tax-free and remains completely out of the hands of Uncle Sam (so long as you follow a few key distribution regulations like the five-year rule). More pressingly, especially for older Americans who might have spent a lot of their working life in the pre-Roth era, there remains an opportunity to convert your traditional IRA into a Roth. But how, why, and when might you do it? Good question; here's the scoop.

First and foremost, the ability to enjoy tax-free investment growth is a massive benefit. This is the underlying reason that drives any conversation about a conversion from a traditional IRA to a Roth IRA. Withdrawing funds from your traditional IRA will come with pesky tax calculations, tricky accounting to limit your exposure, and more. And, that's on top of the already turbulent landscape of maintaining portfolio stability while working to distribute funds to yourself to pay for retirement.

Converting your IRA to a Roth eliminates a major headache later on, and can allow you to pass on a tax-free retirement fund to your spouse that doesn't require any additional maintenance, special considerations, or distribution demands. A Roth IRA is, in many ways, a superior savings tool to the traditional retirement account that many workers will have contributed to. Although it's worth noting that both exhibit their own unique strengths and circumstantial benefits; as a result, the Roth isn't universally a better option for everyone. Even so, making the conversion gives you enhanced flexibility and relaxed rules for how to use and manage your retirement funds as you prepare to enter retirement and later as you navigate retired life.

Traditional IRAs are required to make required minimum distributions, or RMDs, starting at age 73, and the amount you're paid out from the account is based on math dictated by the IRS. You can withdraw more, but you can't slow the flow. Moreover, distributions from a traditional IRA are treated as regular income, and taxed as such on a yearly basis. Since you can't control your low end, you also can't engage in effective tax-management strategies. If your IRA has grown steadily throughout your career, the RMD figure set forth by the IRS (based on equal distributions across your estimated life expectancy) may be fairly significant.

A Roth conversion will help you avoid all this, and brings in the benefit of continuing to grow as much of your portfolio as you desire for the remainder of your life. A Roth IRA doesn't come with RMDs attached, so you can decide to never withdraw these funds (although that's not likely to be a very useful retirement strategy). Avoiding required distributions allows you to continue growing your portfolio, limiting your withdrawals to as little as you'd like to protect your principal value or certain assets within the portfolio. What's more, since a Roth is already taxed, you could instead withdraw the entire sum in a single distribution without moving the needle on your year-end tax bill.

Ideally, you'll be considering a Roth conversion early in your career. Generally speaking, people gradually see their annual salary increase as they progress through the ranks of their company or their sector of the workforce more broadly. The more experience you have, the more you can expect to be paid, as a sort of rule of thumb. This means that the longer you wait to make a traditional IRA-to-Roth IRA conversion, the greater your tax bill might ultimately be.

The primary drawback of a conversion is the requirement of paying taxes on your earnings. Since the money hasn't yet been assessed as income, the entirety of any conversion you make is counted as income for that year. Therefore, the earlier you start to make your conversion — staggered across multiple years — the lower your tax burden on these retirement dollars will ultimately be. More to the point, starting early will generally allow you to take advantage of lower tax rates wholesale. Before you break into upper management or start earning at a senior position, your salary will be lower, allowing for more wiggle room in your use of converted funds.

Young people aren't the only ones who can take advantage of this tool. In fact, many young people making their way through their working years will have had the Roth IRA avenue open to them when they began working. This means that conversion opportunities are geared primarily toward older workers who didn't have the Roth IRA available to them when they began saving for retirement. They'll be hoping to mitigate as much of their future tax bill in their golden years as possible by utilizing strategic conversion opportunities.

Splitting up conversions over multiple years is almost certainly the way to go. Otherwise, you'll thrust your earnings for a single year into some of the highest tax brackets assessed on earnings, scraping away crucial funding from your retirement accounts in the process. Essential to this process, however, is the realization that every individual conversion you make requires a five-year waiting period before you can withdraw the funds tax-free. This means that if you stagger your conversions over a 10-year period, only the first half of those transfers will enjoy Roth liquidity when you reach the final conversion year, and you'll need to wait another five years to access the last batch of capital swapped over to your Roth account.

Perhaps one interesting strategy for utilizing a Roth IRA conversion lies in the option to take early retirement. Many people today opt to retire from their place of work, only to take up a part-time job that feels more rewarding. Whether it's the drastic falling away of responsibilities in a fast-paced corporate setting or simply a change of routine tasks, making a late-stage career change that involves a job with less responsibility, fewer committed hours, and a massively reduced paycheck may be a huge blessing in disguise for a certain subsection of American workers. 

Namely, it's a great option for people hoping to make a Roth IRA conversion in the twilight of their careers. Drastically cutting down your salary can give you the freedom to convert more of your IRA to a Roth account. If you're someone who has already reached their target savings goal and isn't saddled with obligations like high credit card balances or continuing mortgage payments, taking a quasi-retirement in your early or mid-60s instead of continuing on to 67 (full retirement age) or later can give you a few key gap years to continue earning a paycheck (rather than taking Social Security checks early, if that's something you want to avoid), while experiencing a bit more breathing room to move your funds to a more advantageous retirement account. Getting a little creative here is likely going to be your best bet, especially if you're already closing in on the start to your Social Security benefits, and ultimately the initiation of your traditional IRA's RMD date.