Roth conversions gain momentum amid market volatility

[UNITED STATES] As investors navigate market swings triggered by tariff concerns, some are eyeing a potential silver lining: a strategic tax-planning move known as Roth conversions. While potentially advantageous, financial experts caution it's not a one-size-fits-all solution.

The strategy involves shifting pretax or nondeductible IRA funds into a Roth IRA, where future growth and withdrawals can be tax-free. The catch? Taxes are due upfront on the converted amount.

Roth conversions have gained renewed attention amid current economic uncertainty. With market volatility and possible tax changes on the horizon, many are considering ways to lock in tax benefits now, rather than face higher rates later. Proposed tax increases for high earners under the Biden administration could further boost the appeal of converting for those expecting to be in higher tax brackets down the road.

Recent data underscores this trend. Roth conversions surged 36% year-over-year as of December 31, according to Fidelity Investments.

Part of the growing interest stems from a broader understanding of Roth IRAs’ long-term benefits. Unlike traditional IRAs, Roth accounts aren't subject to required minimum distributions (RMDs) during the owner's lifetime, giving retirees more flexibility. And qualified withdrawals, including earnings, are entirely tax-free after age 59½, assuming the account has been open for at least five years.

Market downturns can present an especially opportune time for Roth conversions, says Ashton Lawrence, a certified financial planner and director at Mariner Wealth Advisors in Greenville, South Carolina.

“During periods of market decline, investors can convert a lower account balance and pay less in taxes,” Lawrence explained. “As the market rebounds, that growth then happens tax-free inside the Roth.”

But timing the market is only one piece of the puzzle. Investors must also weigh their overall financial situation, including emergency reserves and debt. “If cash flow is already tight, taking on a tax bill now might not be ideal,” Lawrence cautioned. A staggered approach—converting smaller amounts over several years—can help spread out the tax burden while preserving future tax benefits.

Experts emphasize several key considerations before making the move:

Tax Bracket Dynamics Matter

The biggest variable in deciding whether to convert is your current marginal tax rate compared to your anticipated rate in retirement, says George Gagliardi, a CFP and founder of Coromandel Wealth Management in Lexington, Massachusetts.

Ideally, conversions and other taxable planning moves should happen when rates are relatively low. But higher income from a conversion could trigger other tax-related consequences—such as elevated Medicare Part B and D premiums. Running projections before converting can help avoid unintended costs.

Plan for the Tax Bill

Because Roth conversions trigger ordinary income tax on the amount converted, how you cover that bill matters. Lawrence recommends using outside funds—like savings—to pay the tax, rather than dipping into the converted IRA itself. “Using part of the converted balance for taxes just leaves less to grow tax-free,” he said.

One often-overlooked strategy is converting during low-income years—such as early retirement or a career break—when taxable income is temporarily reduced. “These windows can be ideal for conversions at a lower tax cost,” Gagliardi added. This is particularly relevant for retirees who haven’t begun drawing Social Security or RMDs.

Consider the Impact on Heirs

For some, legacy planning plays a role in the decision. Since 2020, most non-spouse beneficiaries must deplete inherited IRAs within 10 years under the “10-year rule.” That’s prompting some investors to pay the tax upfront through a Roth conversion, potentially relieving heirs from larger tax bills down the line.

“In some situations, it makes sense to shift the tax burden now, especially if heirs are likely to be in higher tax brackets,” Lawrence noted. Others may opt to leave the tax obligation with heirs if they expect their children to be in lower brackets.

“Uncle Sam is going to get his share,” Lawrence said. “But with smart planning, you can decide when and how that happens.”