Advice
What this video’s about
In this special edition of The Market Share, Paul Gifford, Chief Investment Officer at 1st Source Bank, is joined by Ally Powers, who leads our Elkhart office and is a Certified Financial Planner® professional. Their topic is one that comes up frequently in retirement planning conversations: Roth IRA conversions.
A Roth conversion can create valuable long-term flexibility, but the decision involves much more than comparing tax rates. Paul and Ally walk through four questions that can help frame the conversation:
- Who is the money for?
- When will it be needed?
- What will the conversion cost?
- And does the entire account need to be converted at once?
A Roth conversion changes when you pay taxes
Ally starts with a simple analogy from the cartoon Popeye. The character Wimpy was known for saying that he would gladly pay you Tuesday for a hamburger today. A traditional IRA works in a similar way. You receive a tax benefit when contributing, then generally pay income tax when money comes out.
A Roth conversion changes that timing. Money moves from a pre-tax retirement account into a Roth IRA, and the amount converted becomes taxable income for that year. If IRS requirements are met, qualified distributions from the Roth IRA can later be withdrawn tax-free.
As Ally puts it, “A Roth conversion isn’t really about avoiding taxes. It’s about being intentional about when you pay them.”
That makes the decision a planning question, not simply a tax question.
Start by asking who the money is for
Before deciding whether to convert, Ally recommends thinking about the ultimate purpose of the account.
If IRA assets are intended for charity, for example, a conversion may provide less value because qualified charities generally do not pay income tax on inherited IRA assets.
If you expect to use the money yourself, the analysis becomes more detailed. Retirees may rely on IRA withdrawals for income, particularly during the years between retirement and claiming Social Security. That makes expected cash flow and current versus future tax rates important considerations.
The same questions apply when planning for a spouse. A surviving spouse may eventually file taxes as a single taxpayer, potentially changing the tax picture significantly.
For assets intended for children or grandchildren, time horizon and the beneficiary’s circumstances also come into play. A younger beneficiary may have more time to benefit from tax-free growth, but estate planning considerations extend beyond taxes alone.
Time can make a difference
When Paul asks how time affects the decision, Ally’s answer is straightforward: “Simply put, time matters.”
The longer converted assets remain invested, the more opportunity they have to compound within the Roth IRA. That can make the time horizon especially important when evaluating the potential long-term benefit of paying taxes today.
How those taxes will be paid matters too. If you have assets outside the retirement account that can cover the tax bill, the converted amount can remain invested. If paying the tax requires taking money from the retirement account itself, the economics of the conversion may look different.
The question is therefore not only whether a conversion could be beneficial. It is whether the timing and available resources support the strategy.
Consider the full cost, not just the tax bill
A Roth conversion increases taxable income in the year it occurs, so the immediate tax expense is an important part of the analysis. But it may not be the only cost.
For people approaching or already in retirement, additional taxable income could affect Medicare Part B and Part D premiums. Those receiving Affordable Care Act subsidies could also see their benefits affected.
This is where the different parts of a financial plan begin to intersect. Cash flow, retirement income, tax planning, estate goals, and healthcare costs may all influence the decision.
That complexity is also why Ally stresses the importance of coordinating with financial and tax professionals before moving forward.
A conversion doesn’t have to happen all at once
A large traditional IRA or 401(k) balance can make the idea of a Roth conversion intimidating. The resulting tax bill from converting an entire account in one year could be substantial.
But a Roth conversion is not necessarily an all-or-nothing decision.
Many people choose to convert smaller amounts over several years. Retirement may create windows when taxable income is temporarily lower, particularly before required minimum distributions begin or before Social Security benefits start.
Ally compares the approach to building a bond ladder. Rather than making one large move, conversions can be spread across several years as part of a broader strategy.
A partial conversion approach may also help manage some of the tax and healthcare-related trade-offs that can come with a larger one-time conversion.
Conclusion
Roth IRA conversions can provide greater flexibility and the potential for tax-free growth, but the right strategy depends on your goals, timeline, tax situation, and the people you ultimately want the money to benefit.
The most useful question may not be whether Roth conversions are good or bad. It is whether paying taxes today fits your broader financial plan better than paying them later.
Whether you’re preparing for retirement, evaluating a Roth conversion, or planning your legacy, 1st Source Wealth Advisory Services is here to help you make informed decisions with confidence. Subscribe to The Market Share for practical insights that help put important financial planning decisions into perspective.
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