Roth conversions and tax diversification

When you’re planning for retirement, one of the biggest unknowns is what your tax rate will be years from now. That’s why tax diversification can be an important part of retirement planning. By having both pre-tax accounts (like traditional IRAs) and after-tax accounts (like Roth IRAs), you give yourself more flexibility to manage taxes later.

A Roth IRA conversion is one way to add that flexibility—but it comes with trade-offs, including paying taxes on the amount you convert. Whether it makes sense depends on your goals and future tax outlook.

Why a Roth IRA?

A Roth IRA offers the potential for tax-free growth and withdrawals in retirement. Unlike a traditional IRA, you contribute after-tax dollars, so you don’t get an upfront tax deduction—but the trade-off is that qualified withdrawals in retirement are generally free from federal income tax.

Other benefits include:

• Flexibility: You can withdraw your contributions (but not earnings) at any time without taxes or penalties.
• No required minimum distributions (RMDs): Roth IRAs don’t require you to start taking withdrawals at a certain age, allowing savings to potentially grow past RMD age and giving you discretion over when you take withdrawals in retirement.

Keep in mind: There are contribution limits and income caps that limit who can contribute to a Roth IRA.

What are the potential benefits of converting to a Roth IRA?

A Roth conversion lets you move money from a traditional IRA or other eligible retirement account into a Roth IRA.

Why consider it?

• Tax diversification: Having both pre-tax and Roth accounts can give you more flexibility in retirement. Adding in a taxable brokerage account could give you even more options.
• Potential tax savings: If you expect to be in a higher tax bracket later, paying taxes now could save you money long term.

What to consider before converting

Consider these factors to see if a Roth conversion strategy fits your goals and tax outlook. You may have options that could help build Roth balances or reduce tax complications.

Account-specific factors

• Employer plans: If you have a 401(k) or 403(b), check your plan rules.
  1. You may be able to make in-plan Roth contributions, which could help preclude the need for a conversion, particularly if you have a long time horizon.
  2. Some plans allow in-plan conversions, which can help accomplish what’s known as a mega-backdoor Roth.
• Pre-tax IRA balances: Pre-tax balances in IRAs, including SEP and SIMPLE IRAs, affect how much of your conversion may be taxable.
• Self-employed accounts: SEP IRAs, SIMPLE IRAs, or Solo 401(k)s may allow Roth contributions. You should check with the financial services firm providing these plans.
• Unused 529 plan: You may be able to roll leftover assets into a Roth IRA. Read Fidelity Viewpoints: How unused 529 assets can help with retirement planning
• Prior Roth contributions: If you’ve contributed before, you’ve already started the 5-year clock for potentially tax-free withdrawals of any earnings. Roth conversions have their own 5-year rule as well (discussed more later).
• Required minimum distributions (RMDs): If you’re over age 73, you must take your RMD before converting. Roth conversions don’t count toward RMDs. Once in a Roth IRA, no RMDs apply to the original owner.

Tax outlook

• If you expect your future tax rate to be lower, keeping money in a traditional IRA may make sense. If rates are higher or uncertain, a mix of account types may offer more flexibility.

Tax impacts

• Can you pay for the conversion out of pocket? Converting to a Roth IRA means paying taxes on the taxable amount you convert in that year. The IRS treats that money as current year income. That extra income can have a few side effects, like:
  • Increasing your current tax bracket
  • Triggering Medicare premium surcharges
  • Changing how your Social Security benefits are taxed
  • Reducing or phasing out certain deductions created or expanded by 2025’s One Big Beautiful Bill Act

Roth vs. traditional: Why tax rates matter

Here’s how future tax rates can influence which account type may be more advantageous—though some investors may choose to keep both for flexibility.

• If your future tax rate is higher than today’s, a Roth conversion may help. You would pay taxes at today’s lower rate. Read Fidelity Viewpoints: Understanding the retirement income valley
• If your future tax rate is lower, keeping money in a traditional IRA may be better. You’ll pay taxes at tomorrow’s lower rate.
• If rates stay about the same, the difference may be minimal.

Read Fidelity Viewpoints: How tax brackets work

Here’s a hypothetical example: 2 investors, both in the 22% tax bracket, each contribute $7,000 annually to IRAs for 20 years and earn an annual return of 7%. One investor uses a Roth IRA, the other a traditional IRA.

Deductible traditional IRA contributions reduce current-year taxes. In this example, the investor who uses the traditional IRA invests any tax savings into a brokerage account. Interim taxes that may be owed on the brokerage account are not considered. Further, potential capital gains taxes owed on sales in the brokerage account are not considered.

This example shows that even when you claim the tax deduction for a traditional IRA and reinvest those tax savings, the combined value only matches Roth if your future tax rate stays the same—and falls behind if rates rise. For the traditional strategy to outperform Roth, you’d need a significantly lower tax rate in retirement.

_{This hypothetical illustration assumes the investors are eligible for tax-deductible IRA contributions and Roth IRA contributions. Assumptions include contributions of $7,000 made at the end of the year, growing at 7%. Assumed current marginal income tax rate: 22%. Expected marginal tax rate in retirement: 24% and 22%. The example of investing after-tax savings from a traditional IRA does not assume any taxes or fees associated with investing. Note that tax rates may not remain constant for 20 years. Hypothetical pre-tax return on investments: 7%. For the reinvested tax savings, the return assumption is also 7%. Taxes, fees, and any other costs associated with post-tax investing are not considered. This example is for illustrative purposes only and does not represent the performance of any security. Consider your current and anticipated investment horizon when making an investment decision, as the illustration may not reflect this. The assumed rate of return used in this example is not guaranteed. Investments that have potential for 7% annual rate of return also come with risk of loss.}

How do you decide if a Roth conversion is for you?

Unfortunately, no one can predict future tax rates with certainty—except to say that taxes will be due. Specific future tax rates depend on many variables, including:

• Your income in retirement
• Changes in federal tax laws
• State taxes

Because these variables are unknown, a tax diversification strategy in retirement allows you to draw from whichever account best supports your tax goals for the year.

It can be helpful to model a range of scenarios when considering a Roth conversion. A financial professional can help you explore different possibilities and choose a strategy that can work for your situation.

Our calculator can help you decide if converting to a Roth IRA is the right move for you: Roth IRA conversion calculator

If you're not eligible to contribute to a Roth, what can you do?

If your income is too high for a direct Roth IRA contribution, you may still be able to take advantage of Roth IRAs through a strategy known as a backdoor Roth IRA.

It involves making a nondeductible contribution to a traditional IRA and then converting that contribution to a Roth IRA.

If you have no other pre-tax IRA balances (across all your IRAs), you can usually convert a nondeductible contribution to a Roth IRA right away. Converting promptly helps minimize any taxable earnings that could build up before the conversion.

Keep in mind:

• If you have other pre-tax IRA balances, the pro-rata rule applies—your conversion must include proportional amounts of pre- and post-tax money. This is known as the IRA aggregation rule, which means the IRS looks at all of your IRAs. If you have both pre-tax and after-tax money spread across multiple IRAs, the IRS will calculate the taxable portion of your conversion based on the total balance, not just the account you choose to convert. Read Fidelity Viewpoints: Do you earn too much for a Roth IRA?
• This strategy can be complex, so it’s wise to consult a tax professional before proceeding.

Is there a good time to convert?

There’s not a perfect time, but certain situations may make a Roth conversion more appealing.

• Low-income years: If you’re in a low-income year, converting could mean a smaller tax bill.
• Market downturns: When account values are down, converting a certain number of shares means paying tax on a smaller amount, leaving more room for tax-free growth potential later. If you plan to convert a set dollar amount, you’d pay the same tax but could convert more shares.

Other considerations

Before converting, keep these points in mind:

• Taxes: Conversions are taxable events. Make sure you have cash on hand to pay the tax bill without dipping into your retirement savings, ideally.
• The 5-year rule: Each Roth conversion has its own 5-year clock. If you're under age 59½, withdrawing converted amounts before the 5-year mark may trigger a 10% early withdrawal penalty on the initial converted amount. Once you reach age 59½, that penalty no longer applies—even if the conversion is recent.

Finally, you don't have to do this alone. A financial professional can help you choose a tax strategy that works for your situation.