Roth Conversion

Should I Do a Roth Conversion?

By Jim Shellenberger, CFA, CFP®

Retirement is a major milestone, and achieving a successful retirement requires decades of planning and saving. There are several ways to save; one of the most common is a Roth IRA. 

A Roth IRA comes with certain tax benefits, but there are some important differences between a Roth IRA and other retirement planning vehicles. Learn more about Roth IRA conversions here to determine if this strategy is right for you. 

Traditional vs. Roth IRA

A traditional IRA provides a tax benefit on the front end, meaning qualifying individuals enjoy a benefit sooner rather than later. Contributions are made with pre-tax money. Come tax time, the contributions made over the last year are fully or partially tax-deductible based on income and whether you or your spouse is covered by a work-sponsored retirement plan. 

Here’s a breakdown of the 2023 rates based on tax filing status if you are not covered by a retirement plan at work:

  • Single and earn any adjusted gross income: The full deduction to a traditional IRA is tax-deductible up to the contribution limit.
  • Married filing jointly and earn any adjusted gross income: The full deduction to a traditional IRA is tax-deductible up to the contribution limit.
  • Married filing jointly with a spouse who is covered by a plan at work and your modified AGI is beneath $218,000; full deduction but if modified AGI is between $218,000-$228,000: a partial deduction. 

The max annual contributions into a traditional IRA for 2023 is $6,500 (or $7,500 for those over 50).  A traditional IRA also comes with a required minimum distribution (RMD) once you turn 72 years old. Ignoring the RMD will land you a hefty penalty fee.

On the contrary, a Roth IRA provides a tax benefit once you’re ready to withdraw the funds. The money you fund your Roth account with is taxed prior to depositing. When it’s time to cash in, you will not be assessed any further taxes on the initial investment or the gains.  

Unlike a traditional IRA, there is no required minimum distribution associated with a Roth IRA. You may also withdraw contributions at any time. But be careful to not withdraw any of the gains before you’re 50½ years of age to avoid a 10% penalty fee.

Roth IRA Conversion and Taxes

A Roth IRA conversion is when you move funds from a traditional IRA into a Roth IRA. In the case of a Roth IRA conversion, you’re ultimately deciding the tax benefits of the Roth are superior to a traditional IRA, based on your financial scenario.

But how is that determined? Consider the tax bracket you are in today. Now take a moment to consider which tax bracket you may be in when it’s time to retire. Would you rather pay taxes at today’s rate? Or the anticipated rate of the future? Answering these questions is the simplest way to determine if a Roth IRA or traditional IRA better suits you.

Is a Roth IRA Conversion for You?

If you have a traditional IRA but believe you’ll ultimately be in a higher tax bracket once you’re ready to withdraw your funds, then a conversion may be for you. 

Remember, the contributions made into a traditional IRA have not been taxed; so when you convert, you will be required to pay taxes on everything coming out of the traditional IRA before it’s deposited into the new Roth IRA.

With the taxes paid, the conversion can occur. Your funds can now grow tax-free regardless of how high you climb up the tax bracket ladder. The primary goal of a Roth IRA conversion is to lower your tax bill in the future. 

What About Income Eligibility Caps?

There are income caps associated with who is or is not able to contribute to an IRA. Here’s a summary of Roth IRA eligibility based on your modified gross income:

Single Tax Filing Status:

  • $138,000 or less: You can contribute the maximum limit. 
  • $138,000–$153,000 range: You can contribute a reduced amount.
  • Over $153,000: Not eligible

Married Filing Jointly:

  • $218,000 or less: You can contribute the maximum limit. 
  • $218,000–$228,000 range: You can contribute a reduced amount.
  • Over $228,000: Not eligible

What if you see yourself in a higher tax bracket in the future but you’re not eligible to contribute to a Roth IRA? Is there a way to still take advantage of the Roth account tax benefit? At first glance, it may seem as if you’re out of luck. But in reality, there are no income limits associated with a Roth IRA conversion

Backdoor Roth IRA

A backdoor Roth IRA is a work-around for those that exceed the income limits associated with a Roth IRA but are interested in the tax benefit. The process includes depositing money into a traditional IRA and using the “no income limits” Roth IRA conversion. 

During the process, you will have to pay taxes on the contributions and gains to complete the transaction, but you will reach our goal of watching your funds grow tax-free into the future. For the little bit of added effort, you receive your reward upon retirement when you withdraw funds with no tax implications.

We suggest taking a close look at your retirement accounts, current tax brackets, and expectations for the future.

Choose the Retirement Savings Tool for You

It’s to be expected to have questions related to which retirement account is best for you—and anything related to taxes can get confusing in no time. But remember that you don’t have to make these decisions on your own. 

We can help you determine if a Roth conversion is the right fit for you, though we do not provide tax advice, and help you implement the process. Schedule an introductory meeting by reaching out to us at jshellenberger@frontierasset.com or 307.673.5675.

About Jim

Jim Shellenberger, CFA, CFP® is a financial advisor at Elevate Wealth Management, an independent, fee-only wealth management firm serving young professionals, pre-retirees, and retirees in Sheridan, Wyoming, and surrounding areas. With the mission of serving and educating, Jim is dedicated to providing comprehensive, top-notch services that not only help his clients reach their goals, but also empower them to make the best financial decisions for their lives and walk toward their future with confidence. Jim is known for going the extra mile, not only offering valuable knowledge in investment management as a former investment analyst, but building long-lasting relationships so he can give honest, customized advice and strategies that make an impact on their lives. 

Jim has a bachelor’s degree in business administration with a minor in finance from the University of Wyoming. He is proud to be a Wyoming native and loves exploring the outdoors with his family—hiking, fishing, hunting, and backpacking. Faith is an integral part of Jim’s life, and he always looks forward to attending church on Sundays, Bible study on Fridays, and being part of his church community. He’s also an avid sports fan! Fun fact: Jim owns shares in the Green Bay Packers. To learn more about Jim, connect with him on LinkedIn.

The views expressed represent the opinion of Frontier Asset Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Frontier Asset Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. The use of such sources does not constitute an endorsement. Frontier does not have an affiliation with any author, company or security noted within. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and the Frontier Asset Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. Past performance is not indicative of future results.

Frontier does not provide tax advice. Please consult with a CPA for recommendations pertaining to individual circumstances.

Elevate Wealth Management is the financial planning division of Frontier Asset Management. Frontier Asset Management is a Registered Investment Adviser. The firm’s ADV Brochure and Form CRS are available at no charge by request at info@frontierasset.com or 307.673.5675 and are available on our website www.frontierasset.com. They include important disclosures and should be read carefully. 110822DWM110823