When Does a Roth Conversion Make Sense?

When Does a Roth Conversion Make Sense? (Quick Answer)

A Roth conversion may make sense when your taxable income in a given year is temporarily lower than you expect it to be in the future.

Potential opportunities can arise when you:

• Retire or step away from full-time work
• Experience a temporary decline in income
• Have significant assets in tax-deferred retirement accounts
• Experience an IPO or other liquidity event that changes your income or career trajectory

The objective is not to minimize this year’s tax bill, but to evaluate whether recognizing income now improves your after-tax position over time.

What Is a Roth Conversion?

A Roth conversion moves assets from a traditional IRA or other eligible pre-tax retirement account into a Roth IRA.

The taxable portion of the amount converted is generally included in income in the year of conversion. In exchange, assets in a Roth IRA can grow tax-free, qualified withdrawals are tax-free, and Roth IRA owners are not required to take distributions during their lifetime.

Whether that tradeoff works in your favor depends largely on when the conversion is made.

Why Does Timing Matter for a Roth Conversion?

For most high earners, taxable income occurs unevenly throughout their lives. Income may be high during peak earning years, fall during a career transition or retirement, and increase again later as required minimum distributions (RMDs) and other income begin.

Those lower-income periods can create an opportunity to convert tax-deferred assets at a potentially lower tax rate than you expect in the future.

This can be particularly relevant if you have significant assets in traditional IRAs or other tax-deferred accounts that could eventually generate substantial RMDs.

Can an IPO or Liquidity Event Create a Roth Conversion Opportunity?

Potentially—but the opportunity may not occur in the same year as the liquidity event.

An IPO, business sale or other significant wealth-creation event can provide greater flexibility around your career. You may decide to step away from full-time work, change careers, or take an extended break.

If your income declines as a result, those lower-income years may create an opportunity to evaluate Roth conversions.

Selling a significant amount of company stock may increase taxable income in the year of the sale, which is why your planning should consider years beyond the liquidity event itself to identify potential tax-planning opportunities in the years to follow.

How Much Should You Convert to a Roth?

Because a Roth conversion generates taxable income, converting a large balance in one year could push some income into higher tax brackets and affect other tax-related calculations. Partial conversions over multiple years based on your projected income and broader tax picture generally provide more control.

The objective isn’t necessarily to minimize taxes in any single year, but to manage them across your financial lifetime.

How Does a Roth Conversion Fit into Your Financial Plan?

A Roth conversion shouldn’t be considered in isolation.

Your current and future income, tax-deferred assets, liquidity needs, investment mix, and long-term goals can all influence whether—and when—a conversion makes sense.

Holding assets across taxable, tax-deferred and Roth accounts can also provide greater flexibility over where future spending needs are funded and how much taxable income you recognize in a given year.

The question isn’t simply “Should I do a Roth conversion?” It’s “When might paying taxes on these assets create the greatest long-term benefit?”

Frequently Asked Questions

When is the best time to do a Roth conversion?

There is no universal best time. A period when your taxable income is temporarily lower than you expect it to be in the future can create an opportunity to evaluate a conversion.

Do you pay taxes on a Roth conversion?

Generally, the taxable portion of assets converted from a pre-tax retirement account is included in taxable income in the year of conversion.

Is there an income limit for Roth conversions?

There is no income limit that prevents an individual from converting eligible traditional IRA assets to a Roth IRA. This differs from the income limitations that apply to direct Roth IRA contributions.

Can an IPO create an opportunity for a Roth conversion?

Potentially. An IPO itself may not create the opportunity, particularly if selling company stock increases taxable income. However, if the liquidity event is followed by a period of lower income, that period may be worth evaluating for Roth conversions.

Should I convert my entire IRA to a Roth?

Not necessarily. Because conversions increase taxable income, partial conversions over multiple years may provide greater flexibility depending on your individual tax circumstances.

Final Thoughts

Roth conversions are ultimately about when you choose to pay taxes.

Retirement can create a potential planning window, but so can an IPO, business sale, career transition or any other event that changes your income trajectory.

A Freestone Client Advisor can work with your tax professional to identify these opportunities, model potential conversions and evaluate them within your broader financial plan.

The right strategy isn’t simply about whether to convert. It’s about recognizing when the opportunity may be most valuable.

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Important Disclosures: This article is not intended to provide, and you should not rely upon it for accounting, legal, tax or investment advice or recommendations. We are not making any specific recommendations regarding any financial planning, investment or tax strategy, and you should not make any financial planning, investment or tax decisions based on the information in this article. This article is intended to be educational in nature and to discuss a few limited aspects of very complex legislation or other complex subject matters. This article is not a comprehensive or complete summary of considerations regarding its subject matter. We recognize that every individual has different needs and the opinions expressed in this article may not be appropriate for everyone. Please consult with a Freestone client advisor, accountant, or lawyer regarding options specific to your needs. Please note that Freestone does not approve or endorse any third-party content hyperlinked to in this article.