A Roth IRA Conversion or Not? Thoughts From a Utah Financial Advisor

A Roth IRA Conversion or Not? Thoughts From a Utah Financial Advisor

It’s that time of the year again to start thinking about potential year-end tax strategies. In the article, we’ll discuss a topic that the team at Scott Marsh Financial is passionate about: Roth IRA Conversions. But maybe not in the way you think!

While many of our peers promote using Roth IRA conversions, we believe there are better ways to utilize tax-advantaged accounts and develop high-impact tax savings strategies that can protect your hard-earned savings, which we’ll discuss in more detail throughout this article. 

It’s important to recognize that Roth IRA conversions are not the one-size-fits-all solution they are often promoted to be. Your decision should be based on your circumstances, timelines, retirement goals, and future financial needs.  

What is a Roth IRA Conversion?

Converting a traditional IRA to a Roth IRA has huge tax implications because the conversion counts as taxable income. This means you may face a sizable tax bill in the year you convert from one type of IRA to the other. This immediate tax liability could dent your cash flow and significantly impact some of your year-end tax planning.

So, before you move forward with this financial strategy, carefully considering the risks and rewards based on your current and future tax brackets and overall financial goals is crucial.

When a Roth IRA Conversion Could Be Right for You

We’re not saying that Roth IRA conversions should not be used. In certain circumstances, they can be very beneficial. For example, if you anticipate being in a higher tax bracket, converting to a Roth now allows you to pay taxes on your traditional IRA assets when you are in a lower bracket. Once the assets have been transferred, all future growth is tax-free, and most importantly, so are the distributions. 

Consider doctors who are in residencies earning $80,000 a year. Once their residencies end, their income can shoot up to $500,000 a year or higher. In this example, the doctors are moving from a much lower tax bracket to a much higher one. In this example, a Roth IRA conversion can make sense.  

When is a Roth IRA Conversion Not the Best Option for You?

Here are a few scenarios to consider before you decide if a Roth IRA conversion is right for you.  

Short-Term Investment Horizon

A Roth IRA conversion typically benefits individuals with a longer time frame for their investments to grow tax-free. 

When you convert funds into a Roth IRA, you must leave that money untouched for at least five years. That’s a significant period, especially if you might need quick access to those funds for other reasons—an emergency, an investment opportunity, or even a down payment on a second home. In such cases, opting for a Roth conversion could tie your hands financially.

For some, the five-year rule is a minor inconvenience when weighed against the long-term tax benefits of a Roth IRA. But if immediate financial flexibility is crucial for you, there may be better moves than converting to a Roth IRA. 

Also, before making any decisions, you should carefully assess your short-term financial obligations and cash flow needs. The last thing you want is to find yourself cash-strapped and facing penalties for an early withdrawal.

Reducing Your Cash or Savings

Another consideration when contemplating a Roth IRA conversion is how you will pay upfront taxes, especially if you’re short on cash or liquid savings.

Let’s go back to the example above when discussing the doctor in residency. Let’s say the doctor is in the 24% tax bracket and wants to convert a $100,000 traditional IRA into a Roth IRA. 

The immediate tax obligation for the conversion would be $24,000. If you can draw that $24,000 from a separate savings account, your Roth IRA will maintain its full $100,000 value and benefit from tax-free growth. 

On the flip side, if you choose to use the funds from the IRA conversion to pay off the $24,000 tax bill, your Roth IRA will start with a balance of just $76,000. 

This can stunt the growth potential of your savings from the very beginning. Furthermore, if you’re under 59½ years old, using your IRA funds for the tax bill triggers an additional 10% penalty on top of your income tax.

If you’re considering a Roth IRA conversion, planning based on tax efficiency may be the right way to go. 

Get to Know Scott Marsh Financial

Scott Marsh Financial is a fee-only fiduciary investment advisory firm in Utah with a strong commitment to education, innovation, resourcefulness, and growth. 

Tax planning in Utah—or anywhere—requires a well-thought-out plan considering multiple scenarios and outcomes. At Scott Marsh Financial, we specialize in helping create high-impact tax-saving strategies for successful individuals and their families. 

We also believe in the power of behavioral finance. Why? Because its decisions are based on facts vs. emotions that change with the times. This approach identifies how your biases may impact your financial-related decisions, which can impact your ability to achieve short and long-term goals.

Thanks to our educational roots, we offer a unique spin on coaching you through your behavioral finance tendencies. We break it down in a way that’s not just digestible but also actionable—making it more straightforward for you to integrate these insights into your daily financial life.
We invite you to connect with us to learn more about our retirement planning services.

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More about the author: Scott Marsh

Scott Marsh has been referred to as America’s Financial Advisor and Educator. He is considered one of the foremost thought leaders in the financial services industry and hopes to share his knowledge with others so they can create a legacy of financial prosperity. He is the founder of Scott Marsh...