5 Reasons Not to Use Roth IRA Conversions
This is a follow-up to another post that was dropped last week, cleverly titled “4 Reasons to Use Roth IRA Conversions”.
Obviously, it was about reasons you might want to use Roth conversions.
While Roth conversions are an excellent planning tool, they are not for everyone. Here are five circumstances where you might be better off not converting your accounts to Roth.
1) You Don’t Have Many Tax-Deferred Assets
This is probably obvious enough, but if you don’t have any assets or very few in tax-deferred accounts, then you might not want to bother with conversions.
The primary purpose of Roth conversions is to gain control over when your assets are exposed to income taxes.
If the balance in your tax-deferred accounts will generate Required Minimum Distributions (RMDs) that are equal to or below your actual expense needs in retirement, then there may not be much benefit from converting to a Roth.
2) No Cash to Pay the Tax
Since the conversion of assets from a tax-deferred account to a Roth is a taxable event, you need to have some cash available to pay the income tax on the conversion.
And the more money you have, the more this is true.
Let’s assume that you want to convert $50,000 to a Roth IRA and you’re in the 22% tax bracket.
The income tax will be $11,000 for this conversion.
So that means you’ll either need $11,000 available to pay the tax bill, you’ll have to cannibalize $11,000 from your conversion, or you’ll have to remove an additional $11,000 from your tax-deferred account for the tax.
Cannibalizing the Roth dollars is woefully inefficient because you’re basically slapping those funds with a 22% penalty.
And the trouble with using more cash from the tax-deferred account to pay the tax is that you’ll now need another $2,200 to pay the tax that you were removing to pay the tax. Then, another withdrawal of $2,200 will trigger another $484 in taxes.
This cycle will continue until you use available cash to pay the tax, so it’s better just to have the cash available in the first place.
3) You need the money within 5 years
Among the most confusing rules in the world of personal finance is the Five-Year Rule for Roth IRAs.
I won’t bother diving into a lengthy explanation now, but you should know that each conversion you make to a Roth IRA is subject to early withdrawal penalties if you remove funds, earnings included, from those conversions within five years.
However, since this requirement is meant to serve as a discouragement to raiding your retirement account early, it expires once you reach age 59.5.
So, if you have money in your tax-deferred accounts that you want to convert, just know that the five-year rule will apply unless you are 59.5 years old.
3) You want to keep your income taxes low (ERISA & SS)
Since Roth conversions also increase your adjusted gross income, this means conversions could result in higher Medicare payments thanks to IRMAA (Income-Related Monthly Adjusted Amount).
In 2025, Depending on your actual income this could result in a monthly Medicare Part B premium of anywhere from $185 to $628.90. That’s a range of $5,326.80 annually.
Likewise, the amount of your Social Security payments that are exposed to income taxes could be increased as well.
If your AGI exceeds $25,000 for an individual or $32,000 for a married couple filing jointly, then some portion of your benefits will be taxed.
In summary,
- Income under $25,000 (Single) or $32,000 (MFJ) – Not taxed
- Income between $25,000-$34,000 (Single) or $32,000-$44,000 (MFJ) – Up to 50% of benefit subject to tax
- Income over $34,000 (Single) or $44,000 (MFJ) – Up to 85% of benefits subject to tax
4) You Plan to Give Your IRA Away
Finally, if you are a benevolent person and you plan to use your tax-deferred assets to support your charitable ambitions, then you shouldn’t pay tax to convert those funds, as they wouldn’t be subject to income tax as a donation.
Instead, you should look into Qualified Charitable Distributions (QCDs), which are an effective way of reducing RMDs and avoiding taxes while supporting a charity of your choosing.
In fact, if you have money in a variety of accounts that have different types of tax treatment, odds are that making donations from tax-deferred accounts will yield the greatest tax benefits for you.
Donations from a Roth are the least beneficial since Roth withdrawals don’t increase your adjusted gross income anyway.
Wrap Up
Many people see Roth Conversions as master’s-level financial planning, but just because they’re a little exciting from a tax planning standpoint doesn’t mean they’re for everyone.
For more about Roth Accounts, check out our Roth Playlist on the Martin Money YouTube channel.
