Roth IRA Conversions: Is This the Right Year to Pay the Tax?

Deciding whether to convert your Traditional IRA to a Roth IRA is one of the most important financial choices you will make. You are effectively choosing to pay taxes now rather than in retirement. The key is evaluating your current tax bracket to see if shifting those retirement funds makes financial sense this year.

How a Roth IRA Conversion Actually Works

When you put money into a Traditional IRA or a 401(k), you usually get a tax deduction for the year you make the contribution. That money grows tax-deferred. However, when you withdraw it in retirement, the IRS taxes every dollar as ordinary income.

A Roth conversion flips this script. You move money from your pre-tax Traditional IRA into a post-tax Roth IRA. Because you never paid taxes on that money, the IRS requires you to pay ordinary income tax on the converted amount in the year you make the transfer. Once the money is in the Roth IRA, all future growth and withdrawals are completely tax-free.

The primary goal is simple. You want to pay taxes on this money when your tax rate is low, allowing you to avoid paying taxes on it later when your rate might be higher.

The Approaching 2025 Tax Deadline

If you are on the fence about a Roth conversion, the calendar is forcing a decision. The Tax Cuts and Jobs Act of 2017 lowered federal income tax brackets across the board. Unless Congress acts to change the law, these lower tax brackets will automatically expire on December 31, 2025.

Starting in 2026, the tax rates will revert to their higher historical levels. Here is how the brackets are scheduled to change:

• The current 12% bracket will jump to 15%.
• The current 22% bracket will increase to 25%.
• The current 24% bracket will spike to 28%.

Because of this pending expiration, 2024 and 2025 represent a rare window to lock in historically low tax rates. If you are currently in the 22% or 24% tax bracket, converting now guarantees you will not pay the 25% or 28% rates on that money in the future.

Evaluating Your Current Tax Bracket

To decide if this is the right year for a conversion, you must look closely at your 2024 tax picture. A Roth conversion makes the most sense if you are currently experiencing a lower-than-usual income year.

Common scenarios that create a low tax bracket include:

• You recently retired but have not started collecting Social Security or taking Required Minimum Distributions.
• You experienced a temporary job loss or took an unpaid sabbatical.
• You own a business that is reporting lower profits or a loss for the year.
• You have high deductible medical expenses or large charitable deductions offsetting your income.

Financial planners often recommend a strategy called filling the bracket. For example, the 24% tax bracket for married couples filing jointly in 2024 goes up to $383,900. If your expected taxable income for the year is $200,000, you have $183,900 of room left in that 24% bracket. You could convert $183,900 from your Traditional IRA to a Roth IRA, knowing that none of that conversion will spill over into the higher 32% tax bracket.

Paying the Tax Bill with Outside Funds

One of the strictest rules for a successful Roth conversion is having cash on hand to pay the resulting tax bill. You should almost never use the retirement funds themselves to pay the taxes.

If you withhold taxes directly from the IRA during the conversion and you are under age 59.5, the IRS considers that withheld amount as an early withdrawal. You will owe ordinary income tax on it, plus a 10% early withdrawal penalty.

To make the math work in your favor, you need to pay the tax using funds from a separate checking, savings, or taxable brokerage account. If you do not have enough cash sitting in a bank account like an Ally Bank or Marcus high-yield savings account to cover the tax bill, you should reconsider doing the conversion this year.

Watch Out for Medicare IRMAA

A Roth conversion increases your Adjusted Gross Income for the year. This sudden spike in income can trigger hidden costs, especially if you are on Medicare or approaching Medicare age.

Medicare Part B and Part D premiums are tied to your income through a surcharge known as the Income-Related Monthly Adjustment Amount (IRMAA). For 2024, if your income from two years prior exceeds $103,000 as a single filer or $206,000 as a married couple, your Medicare premiums will increase. A large Roth conversion can easily push you over these limits, adding hundreds or even thousands of dollars to your healthcare costs.

Additionally, a higher income year could cause more of your Social Security benefits to become taxable. Up to 85% of your Social Security benefits can be taxed depending on your total income levels.

The Five-Year Rule for Roth Conversions

Even if you are over age 59.5, the IRS imposes a specific timeline on converted funds. You must wait five years before you can withdraw the converted principal without facing a 10% penalty. This rule is separate from the standard Roth IRA contribution rules.

The clock starts on January 1 of the year you make the conversion. If you process a conversion in November 2024, the IRS treats it as if you did it on January 1, 2024. If you plan to spend this money within the next five years, keeping the funds in a Traditional IRA is likely the safer choice.

Frequently Asked Questions

Can I change my mind and undo a Roth conversion? No. Under current tax law, Roth conversions are permanent. The Tax Cuts and Jobs Act eliminated the ability to reverse, or recharacterize, a conversion. Once you move the money and incur the tax bill, you cannot undo the transaction.

Is there an age limit or income limit for Roth conversions? There are no age or income limits for converting a Traditional IRA to a Roth IRA. Even if your income is too high to make direct contributions to a Roth IRA, you can still perform a conversion.

Do I have to convert my entire Traditional IRA at once? Absolutely not. Most experts recommend doing partial conversions. You can convert a specific dollar amount each year to carefully control your tax bracket and spread the tax burden over several years.