5 Reasons Why a Roth Conversion Might Be a Bad Idea

You’ve probably heard the buzz about Roth conversions—they’re often touted as a slam-dunk retirement strategy. The allure of tax-free growth and the option to pull money without worrying about taxes has many investors jumping at the chance. But before you make the leap, it’s essential to know that while Roth conversions are great for many, they’re not the best option for everyone.

We’ll walk you through five reasons why a Roth conversion might not be the right move for your financial situation. We love Roth conversions too, but there are times when it just doesn’t make sense. Let’s break it down below.

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Understanding Roth Conversions

What is a Roth Conversion?

A Roth conversion is when you take money from a traditional IRA or 401(k)—where you’ve deferred taxes—and move it into a Roth IRA. The deal with a conversion is that you pay taxes now in exchange for tax-free growth and withdrawals later.

It’s a way to transfer your retirement savings from the “pay taxes when you withdraw” bucket to “tax-free forever.” Sounds great, right? But like everything in the financial world, there are pros and cons.

Why Are Roth Conversions So Popular?

People love Roth IRAs because of the tax benefits—grow money tax-free and pull it out tax-free. Most investors are drawn to conversions because they want to hedge against the rising tide of future taxes. You pay a tax now, with the hope that you avoid higher taxes during retirement.

We’re huge fans of Roth conversions—when the situation is right. But don’t fall into the trap of assuming they’re a must for everyone.

Let’s discuss five key scenarios when a Roth conversion might not be the smartest move for you.

1. Required Minimum Distributions (RMDs) Are Not a Big Deal for You

What Are RMDs and Why Could They Be a Problem?

Once you hit the age of 73 (as of 2023), you must start taking Required Minimum Distributions (RMDs) from your pre-tax retirement accounts (like traditional IRAs). Each year, you’ll be required to withdraw a percentage of your portfolio and pay taxes on it. The percentage starts small at around 3.6% but creeps up past 8% by the time you hit your 90s.

Here’s where a Roth fits in—Roth IRAs don’t have RMDs, ever. So, if you don’t like the idea of the government forcing you to take withdrawals, a Roth conversion helps dodge that bullet.

But What If RMDs Won’t Be an Issue?

Let’s say your retirement accounts are already mostly after-tax, or maybe you’ve got a large brokerage account and relatively few pre-tax assets. If your RMDs are small enough that they easily cover your basic expenses, you might not need a Roth conversion at all.

Picture a client like Joe and Jane Smith (unfortunately, they aren’t real). Joe and Jane are early in their 40s, living in Philly, and have a high income and a nice financial cushion to show for it. They’ve saved a lot in pre-tax accounts because it made sense based on their income bracket (35% marginal tax). Here’s where things get interesting—when they retire at 65, their RMDs might be high, but if it’s enough to cover their needed expenses, they might not be that worried about RMDs.

If this describes you, why incur the tax hit of a Roth conversion? Your RMDs might simply be part of your retirement income. You may not need to bother with an expensive Roth tax bill if you’re pulling out enough to comfortably live on.

2. You Have a Shorter Life Expectancy

The Role of Time in Roth Conversions

Roth conversions are a long-term play—the more years you have between paying the taxes on the conversion and making withdrawals, the more advantageous they become. Ideally, you want enough time to allow your investment returns to outpace the taxes you paid upfront.

But if you expect a shorter life expectancy—whether due to health issues or family history—you may not have the luxury of waiting years or decades to benefit from the conversion.

Roth IRAs Are Powerful Inheritance Tools

Roth IRAs are a fantastic inheritance tool. Unlike traditional IRAs, which saddle your heirs with taxes, Roth IRAs transfer to beneficiaries completely tax-free. So, if leaving behind a financial legacy is a priority for you, a Roth can make a lot of sense.

But if inheritance isn’t your focus and you’re aware that your time might be limited, the cost-benefit ratio of converting to a Roth diminishes. In these cases, you could simply enjoy the use of your traditional accounts and let RMDs handle providing income before your time comes.

3. You’re Big on Charitable Giving

The Power of QCDs—Qualified Charitable Distributions

Here’s something a lot of people forget—when you’re charitably inclined, there’s another great way to deal with those pesky RMDs. It’s called a Qualified Charitable Distribution (QCD). This fancy term simply means you can send money directly from your IRA to a charity, fulfilling your RMD without paying tax on the distribution.

Let’s use a common example: Say you’re in your 70s, love supporting causes like the Humane Society, and give $50,000 a year. Instead of writing a check from your bank account, you could send that $50,000 straight from your pre-tax IRA. This not only counts toward your RMD but also lowers your taxable income.

When QCDs Beat Roth Conversions

Think about it—QCDs are achieving the same goal as a Roth conversion (lowering your pre-tax assets) but without the hefty tax conversion bill. If you already plan to give away a significant portion of your assets, why not let it fulfill your RMD requirements at the same time? It’s a strategy that’s easy, smart, and satisfies your heart.

If charitable giving is a big part of your retirement plan, this method may be more efficient than doing a Roth conversion.

4. What If Taxes Go Down?

Waiting on the Tax Man

Most people in the financial world agree that taxes are likely to rise in the future. Our national debt doesn’t seem to be shrinking anytime soon. And if current legislation sunsets in 2025, we could face higher tax rates across the board.

But tax cuts can happen, and they do. If, for some reason, taxes drop significantly after you convert to a Roth, you could end up kicking yourself for paying taxes at a higher rate during the conversion process.

Example Scenario: Paying Taxes Now vs. Later

Let’s say you do a Roth conversion at a 24% tax rate, only to find out later that your tax bracket drops to 18% in retirement. You’d lose out on those six percentage points of savings, which adds up—especially when you’re talking about six figures in conversions.

The Role of Your Spending Needs

Even personal spending habits can affect this. If your expenses drop in retirement—say the mortgage gets paid off and you’re done with college tuition—you might need less income, which could land you in a lower tax bracket. In this situation, pulling dollars from a pre-tax account could cost less in taxes than a Roth conversion would have.

Keep the future of your tax bracket in mind before making any big moves with a Roth conversion.

5. You Don’t Have Enough Cash to Pay the Taxes

The High Costs of Roth Conversions

Here’s one for the real-world folks—if you don’t have the cash to pay for the taxes on a Roth conversion, it’s probably not worth it. Remember, you’re choosing to take a tax hit now when you move your money from a traditional IRA to a Roth IRA.

And trust me, you don’t want to fall into the trap of letting the IRS withhold those taxes from your conversion—it ruins your compounding growth. Ideally, you want every dollar of that conversion to get into the Roth to take advantage of tax-free growth.

Need for Cash on Hand

For example, say you’re doing a $100,000 Roth conversion, and it bumps up your tax bill by $30,000. It’s crucial that you have this $30,000 on hand outside of your retirement accounts. If you let the IRS take the $30,000 from your conversion, that’s $30,000 less growing tax-free over the years.

Even if you have taxable assets to cover the tax, it’s best to keep everything growing as much as possible in your Roth. Be sure to plan for quarterly estimated payments too, so you don’t end up blindsided by an underpayment penalty.

Conclusion

Roth conversions are a powerful tool in a lot of retirement strategies, but they’re not for everyone. Before you rush into converting your retirement dollars, carefully weigh the real costs against the potential benefits. From RMD comfortability to charitable donations, from tax rate concerns to available liquid cash—your personal financial situation should guide your decision.

Always remember, there’s more than one way to win the retirement game, and sometimes, sticking with pre-tax savings can be your best path. Consult your financial advisor, weigh all factors, and make decisions grounded in your specific needs. Your retirement future might just thank you for it!

 

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