The long-term tax benefits of a Roth individual retirement account (IRA) seem so obvious that you may assume there's never a good reason to make the switch from a Roth IRA to a traditional IRA. 

Key Takeaways

  • If you're on a tight budget, contributing to a Roth IRA might not be feasible for you right now.
  • Did you convert to a Roth IRA and find yourself in a higher tax bracket? Considering undoing your conversion.
  • Retirees generally have lower incomes and lower taxes. Do you really need the tax break now or then?

You may want to rethink that assumption. Yes, the Roth IRA gets you an investment account that is totally tax-free at retirement. But your personal circumstances may dictate that you convert (or recharacterize, in IRS-speak) to a traditional IRA. Here are five compelling reasons.

You’re Broke

The simplest, if the bleakest, reason might be that you're cash poor, at least at present. You can no longer comfortably pay the immediate income taxes due on the money you're contributing to your Roth IRA.

Converting to a traditional IRA is less of a financial stretch since the contribution to the fund is taken from gross pay, not takehome pay. You'll still be contributing to a retirement account, and you'll get a bit of a tax break for the current year. When you start withdrawing money after retirement, you'll owe income taxes on your contribution and on the investment returns.

There are worse situations, like having no income to owe taxes on.

"In a situation where someone is tight for cash, a traditional IRA contribution will provide more deductions and therefore more cash in hand after tax filing," notes David S. Hunter, CFP®, president of Horizons Wealth Management, Inc., in Asheville, N.C.

Your Roth Account Underperformed

If the contributions that you made to a Roth IRA have suddenly lost value due to market forces, Uncle Sam won't cut you a break. You will still be taxed on the dollars you put into the account that year.

You might save on your tax bill by converting to a traditional IRA. With the switch, you at least defer the reckoning until after you retire. Even then, you are taxed only on what you take out, not on the entire balance.

You Made Too Much This Year

Contributors to a Roth IRA must meet specific adjusted gross income (AGI) levels. In 2019, a single filer's adjusted gross income must be less than $122,000 to take advantage of the full benefits of a Roth IRA. The limit for married couples filing jointly is less than $196,000. There are limited contribution levels for people whose adjusted gross income is a few thousand dollars above those cutoff levels.

If you convert an account, do it by October 15. That is the deadline for filing or amending your previous year’s taxes.

If your adjusted gross income exceeds the maximum level or is hovering near it, you should consider recharacterizing your account as a Roth IRA before the IRS forces you to do so (and threatens you with a penalty until you do.)

You Expect Your Income to Drop

Say you've crunched the numbers on your projected annual income after you retire, and realized you're likely to be in a significantly lower tax bracket. That's not necessarily a disaster if you have determined that your living costs will be lower too.

However, it means that you won't benefit as much from the tax-free distributions that are the key feature of a Roth IRA. And if you convert to a traditional IRA now, you'll get the immediate tax benefit of pre-tax contributions. Maybe the hit on your take-home income of a Roth IRA isn't worth it for you.

"If you are expecting to be in a lower tax bracket in retirement, which is common, then it makes more sense to utilize a traditional IRA," says Mark Hebner, founder and president of Index Fund Advisors, Inc., in Irvine, Calif., and author of Index Funds: The 12-Step Recovery Program for Active Investors. "You forgo paying taxes on contributions at your current higher tax rate and then pay taxes in retirement at a lower tax rate on distributions."

Just keep in mind that required minimum distributions begin at age 70½ for a traditional IRA. There are no age requirements for a Roth.

A Roth Conversion Bumped You Up a Tax Bracket

If you turn a traditional IRA into a Roth IRA, the conversion process will cost you money in the year you do it.

"A smart choice is to have an analysis created by an accountant to see what the tax ramifications will be" before making a conversion, says Carlos Dias Jr., wealth manager at Excel Tax & Wealth Group in Lake Mary, Florida.

If you convert a traditional IRA worth, say, $100,000 into a Roth IRA, your taxable income increased by $94,000. That's the balance of the account minus the $6,000 you're allowed as an annual contribution to the Roth. (You can contribute another $1,000 if you're aged 50 or over.)

That will probably bump you into a higher bracket. Within the world of retirement accounts, this scenario is a true paradox, but it might make converting back again worth it.

In Any Case...

There is one final benefit to the conversion: You are likely to get a refund of the income taxes you’ve already paid for the Roth account.

Whatever your reason for converting an account, keep in mind the calendar deadlines that the IRS imposes. Conversions must be completed by the final date allowed to file or amend your previous year’s taxes. The standard date is October 15th.