When a Roth conversion pays off — and how to fund the tax bill

Financial advisers recommend converting traditional IRAs to Roth IRAs during years when a taxpayer’s income is unusually low, such as the period after leaving work and before starting Social Security. A Roth conversion moves pretax retirement savings into an account where future withdrawals are tax-free, but the act of converting is a taxable event.

Paying the conversion tax from an account outside the IRA preserves more money inside the Roth to compound without future tax. Kevin Knull, CEO of TaxStatus, says using after-tax funds to pay the bill allows the converted balance to grow tax-free and “snowballs on itself.” Miklos Ringbauer, founder of MiklosCPA, adds that debiting taxes from the IRA reduces the amount left to earn tax-free returns.

Advisers commonly recommend partial conversions spread over several years to avoid pushing a taxpayer into a higher tax bracket. Converting up to, but not past, the next bracket can limit the immediate tax hit while shifting assets to a tax-free account.

Clients who expect higher tax rates in retirement or who face large future required minimum distributions may find conversions attractive. A common window is the years between retirement and the start of Social Security or RMDs. David R. Silversmith of Eisner Advisory Group notes that each case varies and advises review by a tax professional before proceeding.

Rules and pitfalls can affect the outcome. Required minimum distributions still must be taken in full; a conversion cannot be used to reduce an RMD in the same year. For example, a $100,000 RMD must be distributed even if a conversion is done that year.

High-income individuals sometimes use a backdoor Roth by making a nondeductible traditional IRA contribution and converting it quickly. The pro rata rule can make part of such a conversion taxable if other pretax IRA balances exist, so accurate tracking of after-tax basis is important.

Conversions can affect other tax and benefit calculations. Income from a conversion counts for Medicare’s Income-Related Monthly Adjustment Amount two years later, can influence eligibility for premium tax credits, and may trigger the 3.8% net investment income tax. Upcoming tax-law changes scheduled for July 2025 could also change phaseouts and deductions tied to income.

Additional limits apply to converted funds. Converted amounts must remain in the Roth for five years to avoid taxes and penalties on early withdrawals. Withdrawals of conversions before five years and before age 59½ can incur ordinary income tax and a 10% penalty. Recharacterizations are no longer allowed; a completed conversion cannot be undone.

Advisers recommend collecting accurate, current tax data — adjusted gross income, all income sources and projected tax rates — and consulting a CPA or enrolled agent. Professional review can identify costly errors, such as double taxation of basis or unexpected interactions with other benefits.