Schwab Roth Ira Conversion Calculator

Schwab Roth IRA Conversion Calculator

Use this calculator to estimate the tax implications and potential long-term benefits of converting funds from a Traditional IRA (or other pre-tax retirement accounts) to a Roth IRA. This tool helps you compare the immediate tax cost against the future tax-free growth and withdrawals.

Understanding the Schwab Roth IRA Conversion

A Roth IRA conversion involves moving funds from a traditional, pre-tax retirement account (like a Traditional IRA, 401(k), or 403(b)) into a Roth IRA. Unlike contributions to a Roth IRA, which are made with after-tax dollars, converted funds are typically subject to income tax in the year of conversion. The primary benefit? All qualified withdrawals from a Roth IRA in retirement are completely tax-free, and the account grows tax-free.

Why Consider a Roth IRA Conversion?

The decision to convert to a Roth IRA often boils down to a bet on future tax rates. Here are the key advantages:

• Tax-Free Withdrawals in Retirement: This is the biggest draw. Once converted and held for the required five years (and you're over 59½, disabled, or using it for a first-time home purchase), all withdrawals are tax-free.
• Tax-Free Growth: Your investments grow without being subject to annual taxes, and the entire accumulated amount is tax-free upon withdrawal.
• No Required Minimum Distributions (RMDs) for the Original Owner: Unlike Traditional IRAs, Roth IRAs do not require you to start taking distributions at age 73 (or 75, depending on your birth year). This allows your money to continue growing tax-free for your entire lifetime, offering greater flexibility for estate planning.
• Flexibility for Heirs: Beneficiaries of inherited Roth IRAs also receive tax-free distributions, though they are subject to RMDs (unless they are an eligible designated beneficiary).
• Anticipation of Higher Future Tax Rates: If you believe your income tax bracket will be higher in retirement than it is today, paying taxes now at a lower rate can be a smart move.

When Does a Roth Conversion Make Sense?

A Roth conversion is often most advantageous in these scenarios:

• You're in a Lower Tax Bracket Now: If you're currently in a lower tax bracket than you expect to be in retirement, converting now means paying less tax on the conversion.
• You Have a Long Time Horizon Until Retirement: The longer your money has to grow tax-free, the more valuable the Roth conversion becomes. The power of compounding works wonders over decades.
• You Can Pay the Conversion Taxes from Outside Funds: Ideally, you should pay the taxes due on the conversion from a non-retirement account. This allows the full converted amount to grow tax-free in your Roth IRA. Paying taxes from the IRA itself can reduce the amount growing and may incur additional penalties if you're under 59½.
• You Expect Tax Rates to Rise: If you foresee a future where federal or state income tax rates are generally higher, locking in your tax rate today can be beneficial.

When Might a Roth Conversion Not Be Ideal?

• You're in a High Tax Bracket Now: If your current tax bracket is significantly higher than what you anticipate in retirement, converting now could mean paying more in taxes than necessary.
• You Need the Money Soon: If you're close to retirement or anticipate needing the funds within five years, the "five-year rule" for Roth withdrawals might complicate things, and the immediate tax hit could be detrimental.
• You Don't Have Funds Outside Your IRA to Pay Taxes: If you have to use money from the IRA itself to pay the conversion taxes, that portion of your retirement savings is lost to taxes and won't grow for your retirement.

Important Considerations:

• The Five-Year Rule: For converted amounts, you must wait five years from January 1st of the year you converted (or be 59½, disabled, or using it for a first-time home purchase) to withdraw earnings tax-free. The converted principal can generally be withdrawn tax-free and penalty-free at any time.
• Pro-Rata Rule: If you have both pre-tax and after-tax money in your Traditional IRAs, the IRS's pro-rata rule applies. Any conversion will be considered a proportional mix of pre-tax and after-tax funds, meaning you can't just convert the after-tax portion without incurring taxes on a portion of the pre-tax funds.
• Impact on AGI: A Roth conversion increases your Adjusted Gross Income (AGI) for the year of conversion. This could potentially affect other tax-related items, such as eligibility for certain deductions, credits, or Medicare premiums.
• Consult a Professional: Roth conversions can be complex and have significant tax implications. It's always advisable to consult with a qualified financial advisor or tax professional to determine if a Roth conversion is right for your specific situation.