When To Roth? Considerations for Choosing or Converting to a Roth IRA

Executive Summary

  • Roth IRAs do not require distributions during the life of the owner, allowing assets to accumulate and transfer income tax-free to next generations.
  • No income tax deduction is allowed for a contribution to a Roth IRA.
  • When deciding between funding a Roth IRA and traditional retirement vehicles, conventional wisdom can be misleading. Income tax rates are an important — but not the only — factor.
  • Conversions of traditional IRAs and 401(k) plans to Roth IRAs require a tax payment, but may provide higher after-tax income in the long run.
  • Persons whose income exceeds the Roth limits may consider paying the tax to convert traditional accounts to Roth. Conversions may be advantageous at a lower tax rate in retirement, before required distributions begin at age 72.

Roth retirement accounts vs. traditional retirement accounts

A Roth retirement accountis funded with after-tax dollars and distributions are tax-free, meaning you pay no taxes on investment growth. Conversely, traditional retirement account contributions are tax-deductible (within strict income limits for IRAs) and distributions are taxable. In either case, no taxes are assessed on the assets while they are in the retirement account.

Tax treatment: Roth versus traditional IRAs

In 2020, the contribution limit for an IRA is $6,000 ($7,000 if age 50 or above) and $19,500 ($26,000 if age 50 or above) for a 401(k). These limits apply to both traditional and Roth retirement accounts.

Distributions must begin at age 72 for traditional retirement accounts and Roth 401(k)s.2 These are known as required minimum distributions (RMDs) and are based on life expectancy. The lone exception to the RMD rule is a Roth IRA — for this reason, it is sometimes wise for individuals in higher tax brackets to consider rolling their assets from a Roth 401(k) to a Roth IRA.

All types of retirement accounts, including Roth IRAs, can be subject to federal estate tax if the decedent’s aggregate assets exceed the exemption from estate tax. The exemption amount in 2020 is $11,580,000. After the death of the owner,  distributions from an inherited Roth retirement account remain tax-free, while distributions from an inherited traditional retirement account are taxable.

Why Roth?

There are four main reasons to consider funding a Roth retirement account:

  • No required distributions
  • Tax-free distributions to beneficiaries
  • Tax diversification
  • Maximized after-tax contributions to retirement accounts

No required distributions to owner

Unlike other retirement accounts, Roth IRAs do not require distributions at age 72. Importantly, this allows assets to accumulate tax-free. Figure 1 illustrates the benefit of accumulating assets in a tax-free account versus annually distributing assets from a tax-free account to a taxable account. To isolate this benefit, we ignore the taxable nature of the distribution itself.

Figure 1: Benefits of tax-free growth

*Growth rate is for illustration purposes only and is not predictive of actual growth

Tax-free distributions to beneficiaries

Roth IRAs inherited by a surviving spouse remain free from any withdrawal requirements. When the assets pass to the next generation or other heirs, all assets must be distributed within 10 years, subject to certain exceptions. Once distributions begin, they remain income tax-free.

Traditional IRAs inherited by a surviving spouse have RMDs based on the surviving spouse’s age. Once inherited by the next generation, they follow the same distribution rules as Roth IRAs, which mandate full distribution within 10 years. The key difference is that traditional IRA distributions remain taxable, and as a result, are not a tax-efficient asset to pass to next generations.

Tax diversification

Funding Roth retirement accounts helps achieve tax diversification. Future tax rates are unknown — an individual may fluctuate between tax brackets or tax rates may change. Holding various account types — taxable, tax-deferred (traditional) and tax free (Roth) — enables tax diversification. Much like portfolio diversification aids an investor, having flexibility to make withdrawals from the most tax-effective account at different points in time aids in managing taxes.

Benefits of maximizing after-tax contributions to a Roth IRA

More money can be contributed to a Roth retirement account on an after-tax basis than to a traditional retirement account. Conventional wisdom suggests that if your tax rate remains static, the after-tax balance in your Roth retirement account or traditional retirement account will grow equally.

The theory assumes that while a full contribution is made to a traditional retirement account, only a net after-tax contribution is made to a Roth account. Following this logic, in 2020 an individual in the 24% tax bracket would make a $6,000 contribution to their traditional IRA, but only a $4,560 contribution to their Roth IRA ($6,000 x [1 - .24]).

As Figure 2 illustrates, if this occurred for 30 years, the after-tax balance in a traditional IRA and a Roth IRA would be equal. However, individuals typically have enough cash to make equal contributions to either a traditional or Roth IRA, without regard to the taxability of the contribution. This results in very different outcomes.

Figure 2: After-tax balance after 30 years

*Growth rate is for illustration purposes only and is not predictive of actual growth

The initial tax savings from a deductible traditional IRA contribution can either be spent or saved. As Figure 3 illustrates, after 30 years of making the maximum contributions, even if the tax benefit is saved each year, the after-tax value of a traditional IRA lags the after-tax value of a full Roth contribution by $33,000 for an individual with an ordinary rate of 24%. The after-tax lag becomes $170,000 if the tax benefit is spent.

Figure 3: After-tax balance after 30 years
Assumes no change in tax bracket in retirement.

*Growth rate is for illustration purposes only and is not predictive of actual growth

However, people are often in a higher tax bracket while working than in retirement. Therefore, some might assume the upfront tax benefit of the traditional retirement account would be greater than the tax benefit of tax-free distributions in the retirement years. As Figure 4 illustrates, however, a higher after-tax balance after 30 years is achieved only if the tax benefit is saved rather than spent.3

Figure 4: After-tax balance after 30 years
Assumes a lower tax bracket in retirement.

*Growth rate is for illustration purposes only and is not predictive of actual growth.

Options for Funding Roth Retirement Vehicles

Roth IRAs

Directly contributing to a Roth IRA is a simple way for young professionals and teens to begin saving for retirement. For many high-income earners, however, direct contributions are not feasible. The IRS places a threshold of modified adjusted gross income (MAGI) at which contributions are no longer allowed (the phase-out). For married couples, the 2020 MAGI limit is between $196,000 and $206,000, and for singles, the MAGI limit is between $124,000 and $139,000. 

Backdoor Roth contribution

For those who encounter the phase-out limitations, a backdoor Roth IRA contribution strategy exists. This involves making a nondeductible contribution to a traditional IRA, which then is converted to a Roth IRA. This strategy is available no matter how much income is earned. Without a tax deduction on the original contribution to the traditional IRA, on conversion there is income tax only on the appreciation that has occurred between contribution and conversion.

The backdoor strategy is ideal when an account holder has no existing traditional IRA assets. If other traditional IRA assets exist, the individual must include those assets in calculating the tax owed on any conversion. This is known as the pro-rata rule and results in a portion of the conversion being taxable. To avoid this, some employers may allow the plan owner to roll in existing IRA funds to an employer-sponsored 401(k) plan. This eliminates the existing traditional IRA and allows the IRA holder to avoid taxes on conversion.  

Roth 401(k)s

Roth 401(k)s are employer-sponsored plans offered in tandem with a traditional 401(k) account. The Roth 401(k) is funded with employee after-tax dollars that receive the same tax-free distribution benefits as Roth IRAs. Unlike direct contributions to Roth IRAs, anyone can contribute to a Roth 401(k) regardless of income level. In 2020, participants can elect to contribute up to $19,500, or $26,000 if over 50, to 401(k)s regardless of the split between Roth and traditional 401(k)s. As previously stated, because the contribution limits are the same for Roth 401(k)s and traditional 401(k)s, employees are able to contribute more after-tax dollars to a Roth 401(k) than to a traditional 401(k). Viewed from an employee’s perspective, 100% of a Roth 401(k) is available for retirement spending, while for someone in the 24% tax bracket, only 76% of a traditional 401(k) is available for retirement spending since 24% of all distributions are paid in taxes.4

Employer matching contributions cannot be after-tax, so matching contributions flow to a traditional 401(k) account and will be taxed upon withdrawal. Even for employees fully contributing to a Roth 401(k), there is some level of tax diversification achieved through employer matching contributions. 

RMDs do apply to Roth 401(k)s. While these distributions are tax-free, the distributed assets no longer grow tax-free. If it’s desirable and appropriate for someone to avoid the RMD rules, we would generally advise rolling over a Roth 401(k) to a Roth IRA. 

Roth IRA conversions

This is a popular way to fund a Roth IRA for high-income earners who exceed the threshold of tax-free contributions. Important to note, however, is that the assets will be subject to income tax in the year converted. In essence, individuals prepay the income tax due on distributions from their traditional IRA or 401(k) and move the assets to a Roth IRA, where there are no distribution requirements and any distributions occur tax-free. 

Is a Roth conversion right for me?

There are numerous factors to consider when deciding whether a Roth IRA conversion is appropriate, including:

1. Are there taxable funds to pay conversion tax?

The availability of non-retirement assets to pay the conversion tax would allow you to fully convert your traditional IRA assets to a Roth IRA, resulting in more retirement assets invested in a tax-free account. 

2. What is the time horizon for these funds?

A long time horizon for the converted funds extends the value of compounding tax-free growth. Candidates for a Roth conversion generally do not need to spend down the funds during their lifetime. If converted assets need to be distributed to satisfy living expenses, this limits the benefits of extended tax-free growth. In situations where some, but not all, of the assets are needed to fund living expenses, a conversion of a portion of the assets may be the best strategy.

3. Who are the future beneficiaries?

Traditional IRAs remain taxable to the beneficiary while Roth IRAs remain income tax-free. If the future IRA beneficiaries, after the death of the surviving spouse, are heirs, they will inherit tax-free assets. If the intent is to leave an IRA to charity, conversion to a Roth IRA will not be as useful, as charities are tax-exempt organizations and do not benefit further from inheriting a tax-free account.

4. What is your current tax situation?

A Roth conversion is appealing in a year when there are favorable tax attributes, such as low income or large deductions. A common time frame for low income years are the years after retirement and before age 72, when required distributions from traditional retirement accounts must begin. This makes that time frame an ideal time to consider Roth conversions.

The presence of large deductions may reduce the increase in taxable income from the Roth conversion. A potential strategy for the charitably-inclined individual involves pre-funding future years of giving in the year of conversion through the use of a Donor-Advised Fund. The DAF funding creates a large charitable deduction which may be used against the conversion income.  

Figure 5 shows the theoretical increase in assets year-over-year if a traditional IRA were converted to a Roth IRA using both nontaxable funds from the IRA (inside funds) and taxable (outside) funds to pay the conversion tax. This example assumes the individual has enough taxable funds to pay both the conversion tax and cover living expenses for 30 years. Therefore, there will be no need to withdraw funds from his Roth IRA. Paying the conversion tax with outside funds results in a 9.2% increase in assets, whereas paying the conversion tax with inside funds results in only a 4% increase in assets. 

Figure 5: Percentage increase in assets over 30-year period (age 60 – 90)

*Growth rate is for illustration purposes only and is not predictive of actual growth.

5. Are market valuations high or low?

The taxable amount of the conversion is based on the value of the assets being converted. A temporary market decline would reduce the value of the assets in an existing account and allow more assets to be converted at a lower value. Figure 6 shows the impact a temporary market decline would have on the effective tax rate for an individual in the 37% tax bracket.

Other considerations

A decision to convert is irrevocable. Prior to the 2017 Tax Cuts and Jobs Act, an individual could change their mind and recharacterize the IRA to effectively undo the choice. Now, a decision to convert involves full commitment.

Conversion income may also have an impact on net investment income, taxation of Social Security benefits, or Medicare premiums. A tax professional should conduct careful analysis on the conversion strategy and the related tax implications for each individual. 


Roth IRAs have a number of features that make them potentially attractive to individuals, such as the lack of required distributions, the existence of tax-free distributions and the possibility of generating more after-tax dollars than the traditional IRA. Higher-income individuals, though they may be barred from outright contributions to Roth IRAs, may consider converting traditional IRAs to Roth IRAs.

For anyone interested to discuss this matter in more specific detail, please do not hesitate to contact your Relationship Manager.