3 Strategies for Reducing Roth IRA Conversion Taxes

August 20, 2021
How to make the most of a Roth IRA conversion.

A Roth IRA conversion may be right for you if your income is too high to contribute to a Roth IRA outright ($140,000 and up for individuals in 2021; $208,000 and up for married couples filing jointly). With this strategy, you convert all or part of your traditional IRA to a Roth IRA and pay regular income taxes on the converted amount.

It may seem counterintuitive to pay taxes now that you could put off until later, but doing so will allow you to take advantage of a Roth IRA's main benefit: tax-free withdrawals of contributions and earnings in retirement (so long as you’re age 59½ or older and have held the account for at least five years).

"It's an attractive option for individuals who believe their tax rate may be higher in retirement, or for those who just want the flexibility that tax-free income provides," says Rob Williams, managing director of financial planning at the Schwab Center for Financial Research. "And, unlike tax-deferred retirement accounts, Roth IRAs aren’t subject to required minimum distributions beginning at age 72."

If you think a Roth IRA conversion might be right for you, Rob points to three tax-efficient strategies:

  1. Max out your bracket: Let's say you’re single and make $145,000 a year, which puts you in the 24% tax bracket. The next bracket doesn't kick in until your income exceeds $164,925, so you could convert $19,925 ($164,925 – $145,000) and still stay within your current bracket.
  2. Spread it out: Breaking up the conversion across multiple years can make the tax hit easier to manage—and could, when combined with the strategy above, reduce the overall tax you pay on the conversion.1
  3. Get ahead of tax changes: If upcoming changes to tax law will adversely affect future taxes, converting some or all of your traditional IRA in the year preceding the change could help you avoid paying more tax on the conversion than necessary.

In any case, you may want to wait until the end of the year to perform the conversion. "That way, you can account for any year-end changes to your total taxable income,” Rob says.

1For savers younger than 59½, each conversion must be held for at least five years to be eligible for penalty-free withdrawals of the conversion principal.

Which IRA is right for you?


 

IRA Rules: 8 Things You Need to Know

When you're ready to choose an IRA, one of your first tasks is to figure out how the rules for each type of IRA line up with your personal situation.

Must-Ask Questions: Roth IRA Withdrawals

When retirement is years away, most investors tend to focus more on saving and less on what will happen when it's time to take their money out.

What is an IRA?

Looking for a tax-smart way to save for your future? Find out what an individual retirement account (IRA) is, what the basic benefits are, and how the three main types differ.