Converting a 401(k) to a Roth IRA can potentially provide valuable long-term benefits, but it also triggers a tax bill that you’ll need to plan for. While the taxes on a Roth conversion can’t be avoided, savers can reduce the burden through several strategies like gradual conversions and timing adjustments. Those nearing retirement can weigh whether they have enough time left to offset conversion taxes through decades of future tax-free growth.

Do you need help with a Roth conversion or other retirement planning questions? Try speaking with a financial advisor today.

Roth Conversion Mechanics

When moving savings from a traditional IRA or 401(k) to a Roth IRA, savers must pay income tax on the converted amount since this money was originally contributed pre-tax. These conversion taxes are unavoidable, so there’s no way to completely get around paying income taxes on a Roth conversion. Taxes are levied on Roth conversions as if the money were ordinary income, meaning that a large Roth conversion can trigger a large tax payment in the year of the conversion.

Despite the potential for a significant tax bill, the benefit of tax-free growth going forward may make it worthwhile. Depending on an investor’s time horizon, income sources and other factors, the upfront tax hit may pay off over the long term. (If you have additional questions concerning Roth conversions and other retirement planning topics, consider working with a financial advisor.)

Tax Strategies for Roth Conversions

How you carry out your Roth conversion can impact the taxes you'll pay on it. One way to reduce conversion taxes is to spread the conversion over multiple years rather than all at once. By gradually converting smaller chunks, taxpayers may avoid getting bumped into higher marginal income tax brackets. Spreading a $640,000 conversion over four years, for example, may help utilize more space under lower tax brackets.

Another strategy is to time your conversions for years in which you have lower income from other sources. As with the gradual conversion strategy, this can keep your income from rising into higher tax brackets and potentially limit your tax liability.

Timing is also a key factor in another approach, but this one doesn't look specifically at your income. Instead, it aims to convert pre-tax balances during market downturns. The idea is that when account values are depressed, you can move a larger percentage of your 401(k) into a Roth IRA without triggering as large of a tax bill. (A financial advisor can help you determine whether a Roth conversion is an appropriate strategy for your plans.)

401(k)-to-Roth Conversion in Action

Imagine you’re a 60-year-old single filer with $640,000 in a 401(k) and an annual income that places you, at the highest, in the 24% federal tax bracket in 2024. Converting the entire 401(k) this year would add $640,000 to your income, pushing you into the top 37% bracket on every dollar over $609,350.

Instead, let's consider a gradual conversion. Converting just $128,000 of your 401(k) balance per year over five years would push every dollar over $191,950 into the next-highest bracket of 32%, helping you avoid the 35% and 37% brackets in the process. (Actual results will vary based on annual tax bracket changes and the inclusion of state-level taxes.)

Now let's look at what might happen if you converted your 401(k) in a year when the market was down 10%. The $640,000 balance might decline an equivalent amount, falling to $576,000. While this would still put you in the top 37% bracket, taxes on the converted amount would decline quite a bit. (If you need help running projections like these, consider working with a financial advisor.)

Making the Call

Converting a 401(k) to a Roth IRA may not always be the right move. Before converting, savers should consider their retirement timeline and anticipate whether decades of future Roth growth could outweigh conversion taxes owed now.

Generally speaking, those nearing retirement may not benefit as much as someone who converted earlier in their career when they were in a lower tax bracket. It's also key to work out projections with a financial advisor mapping out various partial conversion scenarios. This analysis can reveal the optimal pace and amounts to convert each year to maximize outcomes.

Bottom Line

Converting a 401(k) to a Roth IRA triggers unavoidable taxes, but paced-out partial conversions may reduce the burden. Converting in years when income is down or the market has declined significantly may also help lower the overall tax bill. Generally speaking, weighing time horizons and projecting tax bracket impacts can inform conversion decisions. Consulting a financial advisor can be helpful when planning major retirement account moves.

Retirement Planning Tips

• A financial advisor can help build a long-term retirement plan. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

• Use SmartAsset's retirement calculator to estimate how much money you could have by the time you retire. The tool also shows you how much you may want to save every month to support your lifestyle in retirement.

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