Roth IRA Conversion

A Roth IRA conversion strategy involves transferring funds from a traditional retirement account to a Roth IRA. While this process entails paying income tax on the converted amount, it offers the opportunity to benefit from lower tax brackets and facilitates tax-free estate planning.

Stephen Kates, Certified Financial Planner™ and personal finance expert
  • Written by
    Stephen Kates, CFP®

    Stephen Kates, CFP®

    Certified Financial Planner™ Professional and Founder of Clocktower Financial Consulting

    Stephen Kates is a Certified Financial Planner™ professional and personal finance expert with over a decade of experience working with individuals and families who need help with their finances. With experience as a financial advisor for two of the largest financial firms in the country, Stephen has worked with hundreds of clients to build comprehensive financial plans to grow and protect their wealth.

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    Michael Santiago
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    Michael Santiago

    Senior Financial Editor

    Michael Santiago, a senior financial editor, joined RetireGuide in 2023. With over 10 years of professional writing and editing experience, he brings a wealth of expertise in creating content for diverse industries, including travel and healthcare. Having traveled to more than 40 countries across five continents and lived in Europe and Asia for several years, Michael's global perspective enriches his work. He combines his strong writing skills, editorial judgment and passion for crafting accurate and engrossing content to enhance the user experience on RetireGuide.

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    Barbara O’Neill, Ph.D., CFP®, AFC®, CRPC®
    Barbara O’Neill, Ph.D. CFP®, AFC®, CRPC®

    Barbara O’Neill, Ph.D., CFP®, AFC®, CRPC®

    Certified Financial Planner™ professional, Accredited Financial Counselor™ and owner and CEO of Money Talk

    Barbara O’Neill is a personal finance expert with 41 years of experience working at Rutgers University. She is a Certified Financial Planner™ professional and an Accredited Financial Counselor™. Currently, she is the owner and CEO of Money Talk, where she writes, speaks and reviews content related to personal finance. In 2020, she authored Flipping a Switch, published in 2020.

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  • Published: October 3, 2023
  • Updated: October 6, 2023
  • 10 min read time
  • This page features 9 Cited Research Articles
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APA Kates, S. (2023, October 6). Roth IRA Conversion. RetireGuide.com. Retrieved May 22, 2024, from https://www.retireguide.com/retirement-planning/investing/accounts/ira/conversion/

MLA Kates, Stephen. "Roth IRA Conversion." RetireGuide.com, 6 Oct 2023, https://www.retireguide.com/retirement-planning/investing/accounts/ira/conversion/.

Chicago Kates, Stephen. "Roth IRA Conversion." RetireGuide.com. Last modified October 6, 2023. https://www.retireguide.com/retirement-planning/investing/accounts/ira/conversion/.

Key Takeaways
  • Roth IRA conversions allow you to shift money from a traditional IRA or 401(k) into a tax-free Roth IRA.
  • Individuals with incomes too high to contribute directly to a Roth IRA can initiate a Roth IRA conversion without any income limitations.
  • Before a conversion, it's important to ensure you have the means to cover the income taxes associated with the funds you'll be converting.
  • Converting funds is wise if you expect to be in a higher tax bracket in retirement, want to leave tax-free money for heirs or add tax diversification.
  • Starting a Roth IRA conversion might not be a prudent decision if you are unable to cover the taxes on the converted funds, find yourself in a higher tax bracket currently than you anticipate in retirement or require access to the converted funds within the next five years.

What Is a Roth IRA Conversion?

A Roth conversion entails transferring your funds from a Traditional IRA or taking a qualified distribution from your employer-sponsored retirement plan, like a 401(k), 403(b), or governmental 457(b), and moving them into a Roth IRA.

The rationale behind a Roth IRA conversion centers on tax savings. When you pay taxes on the funds you transfer to your Roth account today, you’re essentially wagering that your current tax bracket is lower than what you’ll face in the future. This strategic conversion not only reduces your tax liability but also yields greater long-term savings as you increase the amount you convert.

Roth IRA conversions are a strategy to consider if you anticipate being in a higher tax bracket in later life than you are today and if you are seeking tax diversification. There are no income restrictions.
Barbara O’Neill, Ph.D. CFP®, AFC®, CRPC®
Barbara O’Neill Ph.D. CFP®, AFC®, CRPC®

What Is the Purpose of a Roth IRA Conversion?

Roth IRA conversions are used to minimize tax obligations in retirement. While funds in a traditional IRA or 401(k) are taxed as ordinary income when withdrawn, funds in a Roth IRA are not. This is because Roth IRAs are funded using after-tax dollars.

Converting funds into a Roth IRA incurs income tax for the year of the conversion. However, this trade-off grants you tax-free income during your retirement years. Furthermore, your heirs will inherit the privilege of tax-free access to the converted funds upon your passing.

Before proceeding with a Roth IRA conversion, it’s advisable to consult with a tax advisor. They can provide valuable insights into the present and future tax implications of your choice and assist you in evaluating whether conversion aligns with your specific financial goals and requirements.

Pros and Cons of a Roth IRA Conversion

There are pros and cons to a Roth IRA conversion. Consider both when making your decision.

Roth IRA Conversion: Pros and Cons
Pros
  • Minimize taxes in retirement
  • Take advantage of lower tax brackets
  • Tax-free estate planning
  • No required minimum distributions (RMDs)
  • No income restrictions
Cons
  • You’ll owe income tax on any funds you convert
  • Your income subject to taxation for that specific year grows, potentially pushing you into a higher tax bracket
  • 5-year waiting period for conversions made before reaching the age of 59 1/2

How Do Roth IRA Conversions Work?

Anyone who wants to start a Roth IRA conversion can do it, but you must have both types of individual retirement accounts — a traditional IRA account and a Roth IRA account. You can open either at almost any financial institution. After setting up your Roth account, reach out to the administrators of your IRA or 401(k) and specify the amount you wish to transfer to your new account.

When tax season arrives, it’s essential to complete Form 8606, which serves to inform the IRS about your Roth IRA conversion. Be sure to account for the conversion taxes when filing your annual tax return for that year.

If you execute a Roth IRA conversion before reaching the age of 59 1/2, you’ll initiate a five-year waiting period. Within this waiting period, any withdrawals of converted funds may incur a 10% early withdrawal penalty, even if you are older than 59 1/2 when you make the withdrawal.

Common Conversion Types

There are three common types of Roth IRA conversions: traditional IRA to Roth IRA, 401(k) to Roth IRA and backdoor Roth IRA conversions. To determine which one aligns best with your financial goals, it’s advisable to consult with your financial advisor.

Roth IRA Conversion Types
Traditional IRA to Roth IRA Conversion
This type of conversion involves transferring funds from a traditional IRA to a Roth IRA. This action triggers income tax on the converted funds.
401(k) to Roth IRA Conversion
401(k) to Roth IRA conversions follow a similar process as traditional IRA to Roth IRA conversions. They involve moving funds from a 401(k) plan into a Roth IRA.
Backdoor Roth IRA Conversion
This conversion method is commonly employed by individuals with incomes that exceed the direct contribution limits for a Roth IRA. They initially deposit funds into a traditional IRA and subsequently convert these funds into a Roth IRA, effectively bypassing the income restrictions. In a Backdoor Roth IRA conversion, it is important to try to avoid converting post-tax Traditional IRA contributions while pre-tax Traditional IRA contributions still exist in the same or another Traditional IRA. Consult a tax advisor before making a Backdoor Roth IRA conversion to ensure you do it correctly.

Examples of a Roth IRA Conversion

There are many ways a Roth IRA conversion can play out depending on your circumstances. It’s important to understand the consequences of starting a conversion, particularly regarding tax implications.

Suppose you earn $60,000 a year and want to convert $30,000 in either a traditional IRA or a 401(k) to a Roth IRA. In 2023, your income puts you in the 22% federal tax bracket. If you go through with the conversion, you’ll pay $6,600 in federal taxes (State taxes may add more to your tax bill).

Taxes on the same Roth IRA conversions can be higher for those who have higher incomes. Higher incomes can result in more substantial tax liabilities during the conversion process because the conversion amount is considered to be ordinary income at the highest applicable tax bracket for the filer. For example, someone who makes $200,000 a year and wants to convert that same $30,000 using a backdoor Roth IRA conversion would pay $9,600 in federal taxes on that money.

Roth IRA Conversion Rules

When contemplating the conversion of one or more of your retirement accounts to a Roth IRA, it’s essential to familiarize yourself with a few key rules.

What Are the Rules?
Eligibility
Anyone with funds in a traditional IRA or 401(k) can perform a Roth IRA conversion. There are no income restrictions.
Taxable Conversion
You will owe income tax on any pre-tax dollars you’re converting to a Roth IRA.
Pro-Rata Rule
The pro-rata rule comes into play when you convert funds from an account containing both pre-tax and post-tax money. This rule mandates that you calculate the ratio of post-tax funds to the total of all pre-tax funds in the account. This ratio determines the percentage of your conversion funds that will be considered non-taxable.
Deadline for Conversion
You must complete a Roth IRA conversion by December 31 of the year in which it was started.
Recharacterization
Recharacterization is a mechanism that enables you to treat contributions made to one type of IRA as if they were initially made to another type. For instance, you can recharacterize contributions made to a traditional IRA as if they were made to a Roth IRA if you notify the IRS of this change before your tax deadline for the current year (i.e., on or about April 15 of the following year or October 15 with extended filing)
Qualified Distributions
In most cases, early withdrawals from converted funds made before the age of 59 1/2 will incur a 10% tax penalty. Additionally, a 10% penalty is typically applied if you withdraw money from your converted funds during the five-year post-conversion waiting period. It's essential to be aware of these penalties when considering withdrawals from a converted Roth IRA.

Always consult your financial advisor before proceeding with a Roth IRA conversion. They will offer guidance tailored to your needs and circumstances, explaining the tax implications and ensuring your compliance with all rules and regulations.

Is a Roth IRA Conversion Right for You?

When deciding whether to initiate a Roth IRA conversion, you have several factors to consider. These include tax implications, your retirement objectives, your current financial situation and the anticipated timing of your need for the funds.

You cannot reverse a conversion outside of the recharacterization period, so it’s important to carefully weigh this decision. Consulting with a financial advisor will help you understand the process.

When a Conversion Makes Sense

In some cases, starting a Roth IRA conversion is a smart financial move.

When It Makes Sense
  • Lower current tax bracket. If your current income tax bracket is low, you won't owe as much tax on your converted funds.
  • Anticipated higher future tax rates. If you believe your income is likely to be higher by the time you retire, converting your funds now lets you take advantage of your current lower tax bracket.
  • Long time horizon. If you don’t expect to need the funds in the next five years, the waiting period following a Roth IRA conversion won’t be a problem for you.
  • Diversification of tax exposure. Converting some savings to a Roth IRA will help you protect some retirement income from any future tax policy changes.
  • Estate planning. If you plan to leave your IRA money to heirs, converting it to a Roth IRA will allow your heirs to receive the money without paying income tax.

When a Conversion Doesn’t Make Sense

However, there are some circumstances in which a Roth IRA conversion won’t help you.

When It Doesn’t Make Sense
  • Higher current tax bracket. If you expect to be in a lower tax bracket in retirement, waiting to pay taxes on those funds will net you the greatest savings.
  • Inability to pay taxes. If you lack the means to cover the taxes resulting from a conversion, it's advisable not to proceed with converting your money.
  • Short time horizon. If you anticipate requiring access to the converted funds before the completion of the five-year waiting period, it's best to leave the money where it currently resides.
  • Uncertain future tax rates. If you don't know if your future income will place you in a higher tax bracket, you may be better off investing in a traditional IRA.
  • Limited retirement savings. If you don’t have much saved for retirement, you'll likely owe little in taxes when you withdraw it.
  • Current need for tax deductions. If you need tax deductions to reduce your current tax burden, a traditional IRA is a better fit.

Frequently Asked Questions

Do you have to pay taxes on a Roth IRA conversion?
If you convert funds to a Roth IRA, you’ll pay income taxes on that money.
What is a backdoor Roth IRA conversion?
A backdoor Roth IRA conversion is a strategy people use when their income is too high to contribute directly to a Roth IRA. Instead, they contribute to a traditional IRA and later convert the money to the Roth account.
Why do people convert their IRAs?
People convert their IRAs for tax diversification, the anticipation of future tax savings and to enjoy tax-free estate planning.
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Last Modified: October 6, 2023

9 Cited Research Articles

  1. Wohlner, R. (2023, July 17). What Is A Backdoor Roth IRA? Benefits, Limits, Conversion. Retrieved from https://time.com/personal-finance/article/backdoor-roth-ira/
  2. Rose, J. (2023, April 5). The Ultimate Roth IRA Conversion Guide - Everything You Need to Know. Retrieved from https://www.goodfinancialcents.com/roth-ira-conversion-tax-rules/
  3. Dore, K. (2023, March 14). Inflation boosted the 2023 federal income tax brackets. Here’s how your taxes may compare to 2022. Retrieved from https://www.cnbc.com/2023/03/06/inflation-boosted-the-2023-federal-income-tax-brackets.html
  4. Internal Revenue Service. (2023, March 9). About Form 8606, Nondeductible IRAs. Retrieved from https://www.irs.gov/forms-pubs/about-form-8606
  5. Iacurci, G. (2023, February 6). Roth IRA ‘five-year rule’ can trigger an unexpected tax bill: Here’s what you need to know. Retrieved from https://www.cnbc.com/2023/02/06/roth-ira-five-year-rule-heres-what-you-need-to-know.html
  6. Dore, K. (2023, January 22). Roth IRA conversion taxes may be trickier than you expect. Here’s what to know before filing — or converting funds in 2023. Retrieved from https://www.cnbc.com/2023/01/22/heres-how-to-report-roth-ira-conversions-on-your-taxes-.html
  7. Kudla, D. (2022, October 7). Backdoor Roth Conversions And The Pro Rata Rule Caveat. Retrieved from https://www.forbes.com/sites/davidkudla/2022/10/07/backdoor-roth-conversions-and-the-pro-rata-rule-caveat/
  8. Elkins, K. (2020, January 22). How to find out if a Roth conversion is right for you—and how to do one. Retrieved from https://www.cnbc.com/2020/01/22/how-to-do-a-roth-conversion.html
  9. 2010 IRS Nationwide Tax Forums. (2010). Roth Conversions/Retirement Planning for Life Events. Retrieved from https://www.irs.gov/pub/irs-tege/forum10_roth_conversions.pdf