When you’re saving for retirement, a Roth IRA offers a different set of tax advantages than a traditional IRA. Unlike a traditional IRA, where you invest pre-tax dollars, with a Roth IRA, you invest after-tax dollars. And, even though you can’t deduct contributions as you can with a traditional IRA,1 your money grows tax-free and can be withdrawn tax-free in retirement.2 That’s a big benefit that isn’t available with a traditional IRA. Do you have a traditional IRA, but like the idea of tax-free growth and withdrawals? You can convert your traditional plan to a Roth, although you’ll pay tax on the amount you convert since you didn’t pay taxes on the money when you contributed it.

So since you’ll owe taxes on what you convert, does it ever make sense to make the change?
Sometimes it does and sometimes it doesn’t.

A conversion may make sense if:

  • You’ll have low income or no other income in the year you’re converting. If you’re in a lower income tax bracket because of a layoff or time away from the workforce, converting now could save you money because you’ll pay less in taxes while your tax rate is lower. You don’t have to convert the entire balance; you can convert any amount you choose.
  • You’ll retire in a higher tax bracket. No one knows what tax rates will be in the future, but if you believe yours will be higher after you retire, it may make sense to pay tax on the money now. That way you can avoid paying a higher tax rate on withdrawals when you’re retired.
  • You want to pass tax-free money to heirs. Whoever inherits your Roth IRA won’t have to pay federal income tax on the withdrawals, as long as the Roth IRA account has been open five or more years. If it’s been open for a shorter period, they’ll owe tax, but no penalty.

A conversion may not make sense if:

  • You’re likely to need the money within five years. If you’re nearing retirement and expect to make withdrawals within five years, you’ll probably want to keep the traditional IRA because withdrawals from a Roth IRA are only tax-free if you’re age 59½ or older and have held the account for five years or more. If you withdraw the money sooner, you’ll not only end up paying tax, but you’ll also pay a 10 percent penalty. Plus, if you need to use money from the IRA to pay the conversion taxes, you’ll lose all future earnings on that amount.
  • You expect your tax rate to drop. If you expect to have a lower tax rate when you retire, converting now might cost you more in taxes now than you’d save with tax-free withdrawals later.

Are you interested in learning how converting would affect your retirement funds? You can use Navy Federal’s Roth IRA Conversion Calculator to see if it’s a good option for you.

1Deductibility depends on whether you or your spouse is an active participant in an employer’s retirement plan and, if so, on your income. Taxes will be due at ordinary income tax rates upon withdrawal after age 59½ from a traditional IRA.
2Withdrawals are tax-free at retirement if the account holder is at least age 59½ and has held the account for at least five years. Premature withdrawals are subject to ordinary income tax and a 10 percent tax penalty.

This article is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.