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Conversion from IRA

I had a client recently leave his business and do a fellowship, which is to say he’s deepening his skills and honing his niche. One of the downsides of fellowships is that they rarely pay very well. Essentially, professionals in a given field are working for much less than market rates, and in exchange, they build a deeper skill set and are able to earn much more when they return to the private sector.

So as we discussed, we agreed that this year would probably be his lowest income year ever. This is important, because this is perhaps his best year to move an IRA to a Roth IRA. This process is called a Roth conversion, and it involves taking pretax dollars from IRAs, with holding a tax owed on them and moving them to Roth IRAs. Whatever your tax rate is in the year that you trigger a Roth conversion, that is the tax that you pay on those dollars as they go from IRA to Roth. The advantage after that is that these dollars inside the new Roth IRA will generally never be taxed again, assuming you are either 59 ½ years old or meet other criteria when you withdraw the funds. So my friend, when he is in the highest income earning years of his life, will have a bucket of money that will never be taxed again. And we moved the money to that bucket while perhaps paying the lowest taxes he may ever see.

Since none of our blog posts are intended as a substitute for your CPA’s advice, we always ask our clients to run things that have tax implications by their tax advisor and things that have legal implications by their legal advisor. We don’t present isolated case studies as de facto recommendations for all others to do the same. And that’s precisely the point. Part of financial planning is looking at your unique situation and determining what strategies are best to help you reach your goals. As you can see, Roth conversions can sometimes help those with lots of future earning potential to get money to the never-taxed-again side of life before it gets really expensive to do so.