Roth IRA conversion: Thinking about a Roth IRA conversion? This simple BETR method helps you decide fast
Later, when they retire, withdrawals from the Roth IRA are also tax-free, which is why many people like this option, according to USA Today. Unlike traditional accounts, Roth accounts do not require mandatory withdrawals during retirement. These accounts are also easier for heirs because inherited Roth withdrawals are generally tax-free. Taxes are often one of the largest retirement expenses, which is why many people consider switching to Roth accounts.
Why are Generation X considering Roth?
Since Roth IRAs started in 1997, most Gen X workers have mostly traditional retirement savings. Data shows Roth conversions increased 46% in the second quarter of 2024 compared to the previous year. Experts say the decision is not a simple one, because even small differences in a person’s financial situation can change whether the conversion is good or bad. People often compare their current tax rate to the tax rate they expect in retirement to make their decision.
The rule of thumb says that if future tax rates are higher, conversion will be better, and if they are lower, conversion may not work. But Vanguard says this rule of thumb isn’t always true because, as USA Today points out, even if future tax rates fall, there may still be benefits from conversion in some cases. Vanguard recommends using the “BETR” method instead, which stands for Breakeven Tax Rate. BETR shows the future tax rate at which converting or not converting will make no difference.
How does the BETR method work?
People compare expected future tax rates with BETR to make quick decisions. If the future tax rate is equal to BETR, the conversion does not change the result. If the future tax rate is lower than BETR, the conversion will make the person worse off. If the future tax rate is higher than BETR, conversion is a better choice. In one example, an individual in the 35% tax bracket with $100,000 in a traditional IRA expects a retirement tax rate of 24%.
According to USA Today, the account could grow to $300,000 in 20 years, leaving you with $228,000 after paying 24% taxes. If the person had converted, he or she would have paid $35,000 in taxes up front and the final value would have been around $230,000. Even though the future tax rate is lower, the conversion still yields $2,000 more in this example. In this case the calculated BETR is 23.3%, which is lower than the expected future tax rate, meaning the conversion makes sense.
Other things to consider before converting
Experts say BETR is a useful starting point but doesn’t take into account every personal financial detail. People also need to check how their savings are divided between taxable, pre-tax and tax-free accounts. Future income sources, such as retirement, Social Security or military benefits, also factor into the decision. Retirement spending plans and legacy goals should also be considered before conversion. Leaving a large pre-tax IRA to children may force them to pay high taxes later. By law, most non-spousal heirs must discharge inherited IRAs within 10 years and pay taxes on the withdrawals. However, inherited Roth accounts are tax-free if they remain open for at least five years. The BETR method provides a quick math check, but experts say people should still look at their full financial situation before deciding on a Roth conversion, as USA Today notes.
FAQ
Q1. What is a Roth IRA conversion?
A Roth IRA conversion means moving money from a pre-tax retirement account to a Roth IRA, paying the tax now so withdrawals in retirement can be tax-free.
Q2. What is the BETR method in Roth conversion?
BETR is a simple formula that helps people quickly decide whether switching to a Roth IRA will help them by comparing future tax rates.
