For a long time, converting your traditional IRA to a Roth version was a fairly low-risk proposition. If you changed your mind at a later date, you could always reverse course.

That ended with the tax bill President Trump signed in December 2017. The legislation abolished the option to “recharacterize” a Roth conversion back into a traditional, SEP, or SIMPLE IRA, beginning in tax year 2018. It did the same for Roth IRA funds rolled over from 401(k) and 403(b) accounts. There was a brief window until Oct. 15, 2018, in which you could still undo a 2017 Roth conversion. Needless to say, the deadline has passed.

Key Takeaways

  • If you converted to a Roth in 2017, you missed out on lower tax rates. It's too late to reverse that conversion.
  • However, if you have a traditional IRA or 401(k), today's historically low rates should have you considering converting to a Roth.
  • The new rates are in effect until 2025.

On the upside, we've got historically low tax rates right now. So, converting a traditional IRA or 401(k) to a Roth and keeping it there makes more sense than ever. Unless, that is, you're counting on tax rates going even lower than the 10% to 37% rates that are locked in now until 2025.

Effect of Tax Rate Changes

With a traditional IRA, savers contribute on a pre-tax basis and pay ordinary income tax rates when they withdraw the funds in retirement. A Roth account offers similar benefits but in reverse. You pay ordinary taxes now in order to make tax-free qualified withdrawals down the road.

$18,000

The savings on a $200,000 Roth conversion at today's tax rates, compared to the previous rates (assuming a couple with a $100,000 taxable income).

Switching to a Roth makes the most sense if paying Uncle Sam now results in a lower tax liability overall.

Take, for example, a married couple who converted their $200,000 traditional IRA account—consisting entirely of pre-tax money—into a Roth in 2017. Let’s further suppose that they had $100,000 of other taxable income.

Under the previous tax law, their $200,000 account would have been subject to a 33% income tax rate. (Anything you reclassify as a Roth gets added to your adjusted gross income for tax purposes.) The conversion alone would result in a $66,000 payment to Uncle Sam.

Figure 1. The Tax Cuts and Jobs Act lowered marginal tax rates for individuals. The IRS has confirmed that the following rates remain in effect for tax year 2019. (The new rates are set to expire in 2025).

New tax rates and brackets from the Tax Cuts and Jobs Act

Source: Tax Cuts and Jobs Act

Unwinding that conversion before October 15 might have been a wise move. If the couple redid the Roth conversion in 2018 at today’s lower rates, they could have saved some serious bucks, assuming their account balance remains unchanged.

Their $300,000 in taxable income (including $200,000 from the conversion) would now put them in a more lenient 24% tax bracket. Suddenly, their conversion costs them just $48,000—a savings of $18,000.

By the same token, a couple in the same bracket in 2019 or 2020 would be able to convert a traditional IRA or 401(k) and pay for the conversion at today's lower rates.

To Wait or Not to Wait

Keep in mind that the individual income tax cuts passed into law are expected to be in effect until 2025. Congress may extend the cuts or enact a very different tax law. It's impossible to predict.

One sure thing is that today's tax rates are relatively low. And, assuming you continue contributing money and that your money keeps on making money, your account will grow. Every year, it will be harder to pay the income tax bill that comes with a Roth conversion.

But the biggest attraction of a Roth is that you should owe no money on the account ever again. When you start taking the money out, presumably after you retire, you will owe no further taxes on the principal or the earnings.

That differs from a traditional IRA or 401(k), in which you pay income taxes on both the principal and the earnings as you make withdrawals.

Also, keep in mind that you don’t have to convert all your funds at one time. You can limit your tax hit by spreading out the process over multiple years, converting just enough to stay in your current bracket.