• A Roth conversion before year-end may make sense if your income is lower than usual, you expect higher taxes on future retirement withdrawals, or you want more tax-free income in retirement.
• Converting moves money from a traditional retirement account into a Roth account. You generally pay income tax on the taxable amount now in exchange for potentially tax-free qualified withdrawals later.
• Before converting, consider the tax cost, how you will pay it, and whether the additional income could affect other parts of your financial life.

Why December 31 Matters for a Roth Conversion

If you want a Roth conversion to count toward this year’s taxes, the conversion generally needs to be completed by December 31. That is different from making a regular IRA contribution, which may be allowed until the following year’s tax filing deadline.

Some people assume they can make a Roth conversion in April and apply it to the previous tax year. That’s not how conversions work.

I also encourage people to avoid waiting until December 31 itself, and make the important year-end financial decisions now. Financial institutions have their own processing procedures and deadlines, and December is a busy time.

You Don’t Own All the Money in Your Traditional IRA

This is something I talk about frequently because I think it changes how people look at their retirement savings.

When you put pre-tax money into a traditional IRA or 401(k), you are making an agreement with the government. You get a tax benefit now, but you agree to pay taxes when you withdraw that money later.

So, while your name is on the account, you have partners in that money. Those partners are the federal government and, depending on where you live, the state government.

A Roth conversion is essentially a way of buying out those government partners.

You move money from a traditional retirement account into a Roth account and pay the applicable income taxes now. In exchange, future qualified withdrawals from the Roth can be tax-free.

Of course, the question is whether buying out those partners today is a good deal.

What Is a Roth Conversion and How Is It Different From a Contribution?

People often confuse Roth conversions with Roth contributions, but they are two different transactions.

A Roth contribution involves putting new money into a Roth account, generally from your income or savings. Direct Roth IRA contributions have income eligibility limits and annual contribution limits.

A Roth conversion involves moving existing money from a traditional retirement account into a Roth account.  

There are no income limits preventing you from converting a traditional IRA to a Roth IRA, and there is no annual dollar limit on conversions. You may also be able to move eligible money from a workplace retirement plan, although plan rules can affect your options.

The converted amount is generally added to your taxable income for the year, to the extent the money has not already been taxed. You can convert a substantial amount, but that doesn’t necessarily mean you should.

When Does a Roth Conversion Make Sense?

There are several situations where I like to take a closer look at Roth conversions. None guarantees that converting is the right answer, but each creates an opportunity worth evaluating.

You’re in a Lower-Income Year

Lower-income years can be particularly attractive for Roth conversions.

Maybe you recently retired but haven’t started collecting Social Security. Maybe you changed jobs, took time away from work, started a business, or received a smaller bonus than usual.

Whatever the reason, your taxable income may be lower than it was during your peak earning years.

That creates an opportunity to move some retirement savings into a Roth account while potentially paying a lower tax rate on the conversion.

I especially like examining the years between retirement and the start of required minimum distributions on tax-deferred retirement accounts. Depending on your circumstances, those years may offer some useful room for conversions.

You Have Cash Available to Pay the Taxes

This is one of the first things I look for.

If you are going to convert money and owe taxes on that conversion, I generally prefer that you have money outside your retirement accounts to pay those taxes.

Otherwise, you may end up using part of your retirement savings to cover the tax bill, reducing the amount that makes it into the Roth.

That can change the economics of the decision considerably.

You Want More Flexibility in Retirement or for Your Heirs

I like clients to have money in different tax environments.  Having tax diversification allows for flexibility and options as you move through your non-earned income years (retirement).

Traditional retirement accounts, taxable brokerage accounts, and Roth accounts each serve different purposes. Having access to all three can create flexibility when deciding where retirement income should come from.

Roth conversions may also help reduce future required minimum distributions from traditional accounts.

And if leaving money to children or other heirs is part of your plan, Roth assets can offer favorable income-tax treatment, although inherited Roth accounts still have distribution rules.

These are reasons to explore a conversion, especially when your traditional retirement accounts represent a large portion of your wealth.

When a Roth Conversion May Not Make Sense

A conversion adds taxable income to your return, and that can affect more than your tax bill.

I keep a Rubik’s Cube in my office because it illustrates this beautifully. You change one side of the cube, and several other sides change with it.

The same thing happens in financial planning.

A larger conversion could push some income into a higher tax bracket. It might increase Medicare premiums, affect certain healthcare subsidies, or change eligibility for need-based college financial aid.

You also need to think about when you will use the money. Roth IRAs have rules around qualified withdrawals, including five-year requirements. If you expect to need the converted money soon, those rules deserve attention.

And I am not necessarily a fan of converting every dollar in a traditional retirement account.

There may be good reasons to keep some tax-deferred assets available. Future deductions, medical expenses, and your changing income can all influence which accounts are most useful.

Importantly, completed Roth conversions generally cannot be reversed.

This is why I encourage clients to consider the broader tax picture, not just the potential appeal of tax-free income.

How to Complete a Roth Conversion Before Year-End

Once you have decided that a Roth conversion may make sense, the mechanics are generally straightforward. However, I want you to do the planning before moving the money.

Here’s the process I recommend:

1. Run your numbers first. Work with your financial planner and tax professional to understand how much you can convert and what the tax consequences may be.
2. Decide how much to convert. You don’t have to convert the entire account. Sometimes partial conversions over several years make much more sense than one large conversion.
3. Identify the accounts. Determine which traditional retirement account the money will come from and which Roth account will receive it. If the money is in a 401(k), confirm what your plan allows.
4. Arrange a direct transfer. I strongly prefer a trustee-to-trustee transfer, where the money moves directly between institutions or accounts. The IRS permits certain 60-day rollovers, but I would rather avoid unnecessary paperwork and the possibility of an expensive mistake.
5. Confirm the tax payments. Ask your tax preparer whether the conversion means you should make an estimated tax payment or adjust withholding.
6. Review your beneficiaries. While you are working with these accounts, make sure the beneficiary designations still reflect your wishes.

The Deadline Matters, but the Decision Matters More

A Roth conversion can be a valuable tool, but there is no prize for getting one completed simply because December 31 is approaching.

I want you to understand what you are trying to accomplish, how much tax you will pay, and what this decision means for your future purchasing power and financial flexibility.

Sometimes the answer will be to convert this year. Sometimes it will be to convert a smaller amount. And sometimes the smartest decision is to wait.

The important thing is to make that choice with your eyes open.

If you’re considering a Roth conversion and want help understanding how it fits into your overall financial plan, I invite you to fill out my short questionnaire and see if we’re a good fit to work together.

Jessica Lanning, CFP®

Email: jessica@lanningfinancial.com
Phone: (415) 354-5699
LinkedIn: linkedin.com/in/jessicalanning
YouTube Channel: Lanning Financial on YouTube

Lanning Financial Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.