Roth IRAs can reduce your tax bill in retirement, as well as the tax bill for your heirs. But if all you have is a traditional IRA, does it make sense to convert it to a Roth? Here is a closer look at the reasons you might want to make that move.

Knowing the Roth Benefits

Before we explore the three big reasons to convert, let’s first take a quick look at the benefits of a Roth: 

  • No tax on withdrawals after the account has been open for at least five years.
  • Money grows tax free, but you do pay income tax on the amount of money deposited, unlike a traditional IRA where the deposit can reduce your current income tax bill.
  • You are never required to take distributions. Owners of traditional IRAs must take required minimum distributions (RMDs) starting at age 70½.
  • The IRA can be a tax-free bequest to your heirs. Your heirs will need to take RMDs, but they won’t be taxed as long as the account was open for at least five years.

Primary Reasons to Convert

Given these benefits, here are the three primary reasons to consider a conversion of your traditional IRA to a Roth IRA.

1. Your income and tax rate are lower now. Early in your career, when you're likely to be single, without family obligations and earning less than $37,450, your tax bracket will probably be pegged at 15% – or even lower, given that Donald Trump has promised to lower taxes when he becomes president. (See more here.) As you advance in your career, earn more money and go from a single to head-of-household taxpayer, your tax bracket increases. Currently, the big jump happens when your income reaches $52,000. Income tax brackets over $52,000 range from 25% to 39.6%, depending on your total household taxable income (see Which Income Class Are You?). Even under a new Trump tax plan, your taxes would still increase if you make more money.

If you expect to have much higher earnings later in life and in retirement, the time to convert to a Roth is when your income taxes are in the 15% to 25% bracket. But be sure that the amount converted will not throw you into a higher tax bracket. You will need to plan your conversion carefully over a number of years to avoid a greater tax hit because you will owe taxes on the money being converted. It works like this: The amount converted will be added to your current income, and your tax bill will be based on your total household taxable income.

2. You're In a low income period. Another good time to consider converting is when you are in a low-income period, such as after a layoff or another period of reduced income. Some families will convert when a parent takes a leave of absence after the birth of a child and before the parent goes back to work. You may even be able to avoid taxes on the conversion completely if you convert only the amount that is equal to your standard deduction plus your taxable exemptions minus any earned income.

Let’s suppose that one spouse takes two years off after the birth of your second child. Your household income drops to $20,000 a year. You are married filing jointly with no other income and you have two children. Your standard deduction in 2016 would be $12,600, plus you could add $4,050 per person for the personal exemptions, which comes to $16,200 for the four of you. Total household income could exceed $28,000 and you would still owe no taxes. So if there were no other income than the $20,000, $8,000 of that could be converted to a Roth without having to pay any taxes at all. In addition, tax credits may also help you to get a refund.

Converting to a Roth can also make sense once you are retired. “A client of mine with a salary of about $90,000 decided to take early retirement. With deductions and issues with her rental properties the year after, she was able to convert about $45,000 of her traditional IRA to a Roth without paying any tax!” says Carlos Dias Jr., wealth manager and founder of Excel Tax & Wealth Group in Lake Mary, Fla.

3. You are doing estate planning. The Roth IRA can become an excellent estate planning tool (see Estate Planning Basics) when used correctly. But if you do plan to convert a traditional IRA to a Roth IRA for this purpose, be sure to consult your tax accountant or financial advisor (see Tax Treatment of Roth IRA Distributions). By converting, you can pay the tax bill for your heirs and provide them with a tax-free annuity as long as they follow the required minimum distribution rules for heirs. You also avoid gift taxes on the money converted to the Roth IRA (see Safe Tax Planning for High-Net-Worth Filers).

Should you consider a Roth conversion? Here is an excellent tool that lets you take a quick look at the numbers.  

The Bottom Line

Converting your traditional IRA into a Roth IRA may make sense in certain circumstances. If you are thinking about doing it, run the numbers using the calculator above. Then talk with your tax accountant or financial advisor to be sure it makes sense for you.