8 Times Converting a Traditional IRA to a Roth Makes Tons of Sense

There's no question that saving for your golden years is a good idea. But choosing the right place to grow your wealth can be tricky.

Many people contribute to a traditional IRA but later decide to move the money into a Roth IRA instead. Fortunately, the law allows you to make such a conversion.

Here are a few instances where converting your traditional IRA into a Roth IRA might pay off.

Roth IRAs differ from traditional IRAs in a few ways. The biggest difference is in how a Roth IRA contribution is taxed.

Unlike with a traditional IRA, you don't get a deduction in the year of your contribution. However, the money does grow tax-free, and you can withdraw the funds tax-free during retirement.

Tax-free withdrawals are a major benefit of a Roth, but there are others. You do not have to make required minimum distributions, and passing down a Roth IRA to heirs gives them tax advantages.

In many cases, contributions can be withdrawn at any time without penalty, although early earnings withdrawals may incur taxes and penalties.

Here are some situations where converting a traditional IRA to a Roth IRA might make sense.

This is a good problem to have, but if you make too much money, you might be ineligible to contribute to a Roth IRA.

For example, to contribute the full amount to a Roth, you must have a modified adjusted gross income of less than $146,000 if you are a single filer or less than $230,000 for married couples.

Fortunately, high earners can indirectly contribute to a Roth IRA. With this “backdoor” strategy, you first open a traditional IRA and make a nondeductible contribution. Then, you convert the IRA to a Roth IRA.

The tax man cometh for us all.

When you convert funds from a traditional IRA or 401(k) to a Roth IRA, you'll have to pay taxes on the converted amount. If you have the money to do so, a conversion can make sense.

It’s best to cover the tax owed with savings you have already accumulated instead of holding back part of the converted amount. This allows more money to grow tax-free in the Roth.

Converting to a Roth IRA early in retirement — when income is typically lower than it was during your working years — can reduce your tax bill on the conversion.

In fact, you might consider slowly converting to a Roth over several years as a way to keep your overall tax on the conversion lower. Consult with a tax professional to craft the best strategy for keeping your taxes low.

If you've built up a large nest egg — or if you are looking ahead and expecting your portfolio to grow by leaps and bounds — there is a chance that your taxes will actually be higher during retirement than they are during your working years.

In some cases, converting to a Roth IRA during your working years or gradually doing so early in retirement will cost less in taxes than waiting to make withdrawals from a traditional IRA later on.

Converting can also make sense if you currently live in a low-tax state — such as Texas, which has no state income tax — but plan to move to a high-tax state, such as California, later on.

Nobody likes to see their account balance fall due to a bear market in stocks. But you can take advantage of such a downturn by converting to a Roth IRA.

Because your balance is lower, you'll pay less in taxes on the conversion. With any luck, your balance will eventually rebound after converting to a Roth IRA, and all your gains will be tax-free.

Losing a job is never fun. But one silver lining to a job loss or other income drop is that it creates the opportunity for a Roth IRA conversion at lower tax rates.

Converting funds from a traditional IRA to a Roth IRA counts as ordinary income and will be taxed according to your tax bracket. So, it might be smart to make the conversion in a year when your income is unusually low.

Leaving a converted amount of cash in your Roth IRA for as long as possible maximizes its tax-free growth. That helps offset the initial cost of paying taxes at the time of conversion.

In addition, having more time to let the money grow can benefit your heirs. More on that in a moment.

A Roth conversion can be a good option if you want to provide tax-free income to your heirs. Non-spousal beneficiaries typically don’t get the same tax advantages as spouses, so a Roth conversion can make sense when leaving money to children or others.

Most withdrawals from an inherited Roth are tax-free. However, if the Roth is less than five years old, earnings withdrawals may be subject to income tax.

A Roth conversion might not be the right move for everyone, but it can help others eliminate some money stress.

One key to making a successful Roth conversion is to undertake the process at the right time. If you're unsure of whether this strategy makes sense for you, consult with a financial advisor or tax professional.