“There’s a strong incentive to get money out of a traditional IRA into a Roth so it’s not a time bomb blowing up for people,” says financial adviser David Maurice of Johnson City, Tenn.
In Ms. Owen’s case, she hopes to leave the entire Roth account to her children. She plans to live off other savings and distributions from the remaining money in her tax-deferred account, which is conservatively invested—80% in bond funds. Meanwhile, her Roth account is aggressively invested—80% in stock mutual funds, to maximize its growth, says Alicia Sher, Ms. Owen’s financial adviser at Bluerock Wealth Management.
“This is not money she is going to need to touch,” says Ms. Sher.
In a Roth conversion, pretax dollars are converted to after-tax dollars. In the simplest type, an in-kind conversion, you notify the custodian of your account that you want to move assets, say $50,000 of S&P 500 index fund shares, from your tax-deferred account to your Roth account on a particular day.
When you file your taxes next year, all of the money you converted is treated as ordinary income.
Patrick Rush, the 44-year-old chief executive of Greensboro, N.C.-based Triad Financial Advisors, says his firm did a lot of Roth conversions earlier this year for clients after the stock market shed a third of its value amid pandemic fears.
Mr. Rush himself did a $200,000 Roth conversion of stock mutual funds during the market downturn even though he is in the 37% tax bracket and it cost him approximately $85,000 in federal and state taxes. The funds he converted have now bounced back to around $320,000, above where they were before the market decline. If Mr. Rush had left the money in a tax-deferred account, those gains would be taxed in the future. But all the money he or his heirs take out of the Roth in the future will be tax-free.
While market declines can make Roth conversions more enticing at any age, seniors with low taxable income but bulging tax-deferred accounts ought to do them every year before they hit age 72 and begin required minimum distributions which can push them into a higher tax bracket, advisers say.
Michael Gibney, a wealth manager in Westwood, N.J., has a 65-year-old client who retired last year with low taxable income and a $1 million tax-deferred account. Mr. Gibney will be working with the client’s accountants to figure out the maximum the client can convert for the next seven years and still remain in the 12% tax bracket.
Roth conversions are also a good option for people who are still working and have variable incomes. James Bassett, a New York City financial adviser, has a 57-year-old client who helps companies hire executives. She has a $1.2 million tax-deferred account. Her income this year will be down, so she is doing a large Roth conversion to take advantage of the low tax rates.
She plans to retire in a couple of years, and will be making more Roth conversions after she does, Mr. Bassett says.
Roth conversions don’t make sense for everyone. People who expect their future tax rates to be lower than they are now are generally better off leaving the money in a tax-deferred account. Others may be planning to leave their tax-deferred account to a child with a low tax rate.
“I had to talk one client out of it who was planning on doing a Roth conversion to leave his kid tax-free money,” says Jim Bradley, a financial adviser in Bangor, Maine. In this instance, the client’s child is a social worker, doesn’t earn a lot of money, and won’t be paying high taxes if she inherits a tax-deferred account.
Brandon Jones, a financial adviser in the Minneapolis area, says people need to take a careful look at the entire financial picture before making a decision to go ahead with a Roth. Consider middle-income retirees who are already collecting Social Security. In a certain income range, each additional dollar of income causes 85 cents of Social Security to be taxed, Mr. Jones notes. That could make a Roth conversion, which boosts current income, more expensive than it appears at first glance.
“All of sudden you’re not paying 12%, you’re paying 20% or 30% on every dollar converted,” Mr. Jones says.
He adds: “I’m definitely a fan of Roth conversions. They still make sense in a lot of cases.”
Corrections & Amplifications Most non-spouse beneficiaries of tax-deferred accounts now have to withdraw the inherited assets within 10 years. An earlier version of this article incorrectly stated that was the case for all beneficiaries. (Corrected on Nov. 19, 2020)