How Do Roth IRA Conversions Benefit You in Retirement?

Many people prefer the Roth IRA to other retirement savings plans. The income in a Roth grows tax free, and distributions in retirement are tax free, as well. Distributions from a the plan are not included in your income. This can greatly reduce your income tax liability in retirement. These reasons are why many individuals perform Roth IRA conversions with existing IRA or 401(k) funds.

While these are popular retirement plans, not everyone is eligible to contribute to Retired couple walking in the sandy water on a beach at sunset enjoying There are Roth IRA income requirements you must meet in order to make annual contributions. In 2020, if you’re married filing jointly with a modified adjusted gross income (MAGI) of more than $206,000, or single/head of household with a MAGI of over $139,000—you’re not eligible to open an account.

However, you can open a Roth and perform a conversion with funds from another IRA or 401(k) regardless of your MAGI.

This article explains advantages of Roth IRAs and why you might consider a conversion as part of your retirement planning strategy.

The Basics of Roth IRA Conversions

The main attraction of Roth IRAs is the ability to avoid paying tax on distributions of earnings in retirement. Distributions are not considered ordinary income. And, this can help you avoid higher tax rates and potentially a high annual tax bill in your golden years.

Conversions are performed so people can enjoy these benefits of Roth IRAs:

  • Earnings on investments in the plan grow tax free and are unlimited.
  • Qualified distributions are tax free in retirement.
  • Withdrawals of your contributions can be made at any time without tax or penalty.
  • Roth IRAs don’t require minimum distributions upon retirement, allowing your funds to continue growing in your plan.
  • Once you’ve owned Roth IRA for 5 years and are 59 ½ years or older, you can take tax-free distributions from the earnings in the account at any time, for any reason. The Roth five-year rule clock starts with your very first Roth account.

How Roth Conversions Work

Roth conversions are taxable events. This is important to understand because if you decide to convert, you’ll pay taxes on the funds or assets you convert.

Remember, your regular IRAs and 401(k)s are tax-deferred accounts. Contributions to those plans were made with pre-tax dollars, and you pay taxes on distributions in retirement. In many cases, people are able to take a deduction on their income taxes for contributions to IRAs.

But, Roth accounts are post-tax accounts. Income on investments grows tax free, and qualified distributions from a Roth are tax free. So, if you convert to a Roth plan, the government wants to tax those funds you initially deferred when you contributed to your IRA or 401(k). And they’ll get it when you make a Roth IRA conversion. The amount you convert to a Roth IRA in a given tax year is considered ordinary income in that year. Going forward though, the benefits you gain with a Roth IRA vs. a traditional IRA or 401(k) may make this move worth it, as your funds now will be growing tax free, rather than tax deferred.

Conversion Considerations

It’s important to understand the tax implications of conversions:

  • The amount of money (or assets) converted to a Roth is categorized and taxed as ordinary personal income for the year you make the conversion.
  • Personal losses you may incur for that tax year can help offset the income from the conversion. (Talk to your CPA each year and don’t miss an opportunity to convert with less tax consequence.)
  • Try not to pay the conversion tax with retirement funds. Otherwise, you may be subject to additional taxes and penalties the following year depending on your age.
  • When converting assets (other than cash), you need a current fair market value to use for the conversion. If the value of this asset is historically low, that can be a great time to convert.

The tax on Roth IRA conversions can create a large tax liability for you in your conversion year. Depending on your situation, the tax liability may be more than it’s worth. So, make this decision carefully and discuss it with your tax professional.

Step Up Your Investing Power with a Self-Directed Roth IRA

Self-directed Roth IRAs enjoy all the benefits of a conventional Roth account. But, self-directed accounts have two significant advantages that the conventional account does not.

1. Control over your investing funds and decisions.

When you self-direct your IRA, you are in charge of choosing assets for your plan. You don’t depend on the plan administrator or broker to make these decisions for you. Instead, you use your knowledge and expertise to invest in assets you know and understand.

2. Invest in alternative assets to grow wealth in your plan.

Conventional accounts are limited to investments the plan administrator or custodian sells. But self-directed retirement plans have access to a much wider pool of alternative investments besides traditional stocks, bonds, and mutual funds.

Alternative investments include real estate, private equity, gold, private lending, cryptocurrency, and much more. This is where your knowledge comes into play. You can invest in things you understand to gain critical diversity in your plan and drive higher (tax-free!) returns. And, you don’t have to worry about stock market volatility. You can rest easy knowing your alternative assets have the potential to continue generating income regardless of how the stock market performs.

Alternative investments can earn income at a faster pace than traditional assets. And when you can invest within your own level of expertise, you have the potential to increase your odds for success. This kind of control over your retirement funds and investing decisions allows you to add diversity to your portfolio to help you weather the volatility of the stock market.

In Summary

Roth IRA conversions give you access to Roth IRAs if your income is too high for you to simply open this retirement plan with an annual contribution. Conversions are not considered contributions, which means the income requirements don’t apply in these transactions. If you think your tax liability today is less than you may face in retirement or are concerned with higher tax rates, discuss a conversion with your tax advisor. Converting your current IRA or 401(k) funds may be a great move for you.


If you have questions about Roth IRA conversions or if you want to discover how self-directed retirement plans can help you build retirement wealth, contact Advanta IRA today. We are always happy to help you learn how to maximize the benefits of your retirement plans.

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About Scott Maurer

Scott is an attorney and a graduate of the University of Florida Law School. Scott started his career with Advanta IRA in 2006. His experience with various investment types and their unique processes makes him an invaluable asset. Scott holds the designation of Certified IRA Services Professional (CISP) and leads engaging seminars and webinars that educate the public on the intricacies of self-directed IRAs.