Should You Convert to a Roth IRA Before Retirement?

December 03, 2015

I recently saw this article titled “Why Boomers Should Convert to a Roth IRA” that argues why Boomers should convert to a Roth IRA a few years before retirement. It makes sense at first. Why not pay taxes now and have all your future income from the Roth IRA be tax-free?

I’m generally skeptical of blanket advice like this though. Let’s take a look at an example. Suppose you earn $40k a year, have $100k in a traditional IRA, and are 3 years from retirement. You would be in the 15% tax bracket. According to this calculator, converting that $100k will push you into the 28% tax bracket and cost you an additional $25,393 in taxes.

If you take that from your IRA and are over 59 ½, there’s no penalty. That leaves you with $75,607 in a Roth IRA. After 3 years of 6% growth, that Roth IRA would be $88,858.

Now, let’s say you leave the $100k in the traditional IRA. After the same 3 years and the same 6% return, it would be worth $119,102. To give you 80% of your pre-retirement income, you would need $32k of income from a pension and/or 401(k) withdrawals, putting you in the same 15% tax bracket. You now convert that $119,102 to a Roth IRA, which puts you in the 28% tax bracket. After paying additional taxes of $29,702, you have $89,400 left in your Roth IRA.

As you can see, you’re actually slightly better off delaying converting your Roth IRA until retirement. Even though you’re converting (and getting taxed on) a larger balance and end up in the same tax bracket, it’s offset by the fact that you’re being taxed at a lower average tax rate. Since your taxable income is lower, less of your income is getting taxed at that 28% rate.

But there’s also a third option. By delaying converting your IRA until retirement, you could convert just a little each year to stay in the 15% tax bracket. In that case, you would pay only $17,865 in taxes, leaving you with $101,237 or an extra $12,379 in your Roth IRA.

The point isn’t that everyone should always delay converting to a Roth IRA. It’s that everyone’s situation is different. The best solution for you depends on your taxable income, your account balances, when you take Social Security, etc. If you’re not sure whether it makes sense to convert now or wait until later, consider consulting an unbiased, qualified financial planner. Don’t just take someone’s blanket advice.