A Roth conversion is a transfer from a Traditional IRA to a Roth IRA. Because money in a Traditional IRA is pre-tax (federal and state), the amount of the conversion counts toward Adjusted Gross Income (AGI) in the year it occurs.
Person A has a Traditional IRA with a value of $100,000 and they would like to convert $5,000 of it into a Roth. Their AGI will go up by $5,000 for the year.
A year when income is down (maybe due to a period of unemployment or less income) is a good time to do a Roth conversion.
Captain Case Study
In helping a single mother with comprehensive financial planning, I saw an opportunity for a Roth conversion. Her AGI for the year was going to be about $35,000 and she would be filing as “Single”, as her kids are grown and out of the house. She is over age 59.5 and made no contributions to any retirement accounts for 2020. She had a sufficient emergency fund, a $120,000 Traditional IRA, and no high-interest debt (anything with interest rates over 4%). After taking off the standard deduction of $12,400, she would have a taxable income of $22,600. This puts her in the middle of the 12% tax bracket, with the top of the bracket being $40,125. In order to take advantage of the rest of the 12% bracket (which is a historically low federal tax rate), I helped her process a $17,000 ($40,125 – 22,600 with some room for error) Roth conversion. Being that she is over age 59.5, these new Roth funds are accessible to her penalty-free whenever, but the earnings must stay in the account for 5 years (or there will be a penalty).