A Roth IRA is an Individual Retirement Account to which you contribute after-tax dollars. While there are no current-year tax benefits, your contributions and earnings can grow tax-free, and you can withdraw them tax-free and penalty-free after age 59½, as long as the account has been open for five years.
Retirement savers who convert pre-tax retirement accounts such as IRAs to after-tax Roth IRAs after reaching the age of 60, can keep growing funds tax-free and then make withdrawals in retirement without paying taxes. This is a Roth IRA conversion.
A Roth IRA conversion requires individuals to pay ordinary taxes for the tax year they make the switch, based on the amount of money they convert. When you convert your IRA, it is irrevocable (it is taxable), and it will likely cause a temporary increase in your monthly Medicare costs if you convert beyond the 24% threshold. Under the Tax Cuts and Jobs Act of 2017, you can no longer “recharacterize” or undo a Roth conversion. Once you convert the funds, there’s no going back.
So the question then becomes….is the IRA still worth converting, despite the tax consequence? Let’s take a look at some tax history….
The Tax Reform Act of 1986 lowered the top income tax rate to 28%, which lasted until 1990. It increased to 31%, then 39.6% in 1993.
Although the income tax rate has fluctuated over the years since, the previous administration lowered the rates to the lowest they’ve been in decades. Sadly, this income tax honeymoon won’t last forever. In 2026, the rates are set to return to their previous high. Knowing that taxes are going to go up in the future, converting your IRA now, might be an option worth considering. Otherwise, when you convert later, you could be subject to even more taxes.
Still not sure if a Roth IRA conversion is right for you? The decision to convert to a Roth IRA doesn’t have to be all or nothing. You may find dividing your savings between a Roth and a traditional IRA or a Roth IRA and a traditional 401(k) is the optimal solution for you. Furthermore, tax-free annuities at today’s record high rates could pay 9% or more for life.
Overall, converting to a Roth IRA or a tax-free annuity, might give you greater flexibility in managing RMDs (required minimum distribution) and potentially cut your tax bill in retirement, but be sure to consult a qualified tax advisor and financial planner before making the move, and work with a tax advisor each year if you choose to put into action a multi-year systematic Roth conversion plan.
If you are considering Roth planning so you can leave money to your kids, it’s important to make sure you aren’t overpaying today. Keep in mind, the IRS has already changed the inheritance rules for your children two times in the past three years. At Parady Financial, we will help you explore the most efficient options for passing money on to your family and minimizing your tax penalties with the most appropriate investment options. For more information about our financial planning consultation service, please contact our offices at 352-751-3016.