Articles Is Converting a Traditional IRA to a Roth Worth It?

June 26, 2017

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even though you can’t deduct contributions as you can with a traditional IRA,* your money grows tax-free and can be withdrawn tax-free in retirement.** That’s a big benefit that isn’t available with a traditional IRA.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.

*Deductibility 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.
**Withdrawals 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.

© 2019 Navy Federal Credit Union. All rights reserved.

Navy Federal Credit Union is federally insured by the National Credit Union Administration.

Nondeposit investment and insurance products are offered through Navy Federal Financial Group LLC (NFFG) and through its subsidiary, Navy Federal Brokerage Services, LLC (NFBS), a member of FINRA/SIPC and an SEC registered investment advisory firm. Brokerage and advisory products are offered through NFBS. These products are not NCUA/NCUSIF or otherwise federally insured, are not guaranteed or obligations of the credit union, are not offered, recommended, sanctioned, or encouraged by the federal government, and may involve investment risk, including possible loss of principal. Products may be offered by an employee who serves both functions of accepting member deposits and selling nondeposit investment and insurance products. 1-877-221-8108. Trust Services available through MEMBERS Trust Company. 1-855-358-7878.

Investors should carefully consider the investment objectives, risks, and charges and expenses associated with municipal fund securities before investing. This and other information about municipal fund securities is available in the issuer's official statement which can be obtained directly from the issuer, or if distributed through a broker dealer, may be obtained from a financial adviser, and should be read carefully before investing.

An investor should consider, before investing, whether the investor's or designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program.

If a municipal fund security describes one or more of their investment options as having the characteristics of a money market fund, it is important to know that an investment in the security is not insured or guaranteed by the FDIC or any other government agency (unless such guarantee is specifically provided by or on behalf of such issuer) and, if the security is held out as maintaining a stable net asset value, that although the issuer seeks to preserve the value of the investment at $1.00 per share or such other applicable fixed share price, it is possible to lose money by investing in the security.