Roth IRA Conversion

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on March 06, 2024

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What Is a Roth IRA Conversion?

A Roth conversion is the conversion of a traditional IRA, SEP IRA, or SIMPLE IRA account or a 401(k) account into a Roth IRA account.

The conversion is accomplished by either rolling over the funds from a traditional IRA or withdrawing funds and transferring them to a Roth IRA account.

The main advantage of a Roth conversion is the tax-free retirement income and the absence of required minimum distributions (RMD) in Roth accounts.

The disadvantage of a Roth conversion is that the applicable taxes for such conversions can potentially negate the benefits of the conversion.

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To optimize Roth conversions, consider timing conversions during low-income years to minimize taxes. Strategically convert portions to keep within your current tax bracket. Utilize downturns in the market for conversions, as taxes are based on lower values. Ready to maximize your retirement savings? Let's discuss how a Roth conversion strategy can benefit you.

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Basics of Roth conversions

A Roth IRA account offers several advantages over traditional IRA accounts.

For example, withdrawals after the age of 72 are tax-free. There are also no required minimum distributions (RMDs), making it easier to plan spending.

Under certain circumstances, the transition from traditional IRAs to Roth IRAs makes even more sense.

Some of them are outlined below:

  • If you plan to move to a state with high income taxes, then a Roth conversion will reduce your overall tax liabilities.
  • If you have accumulated substantial savings and expect to be in a higher income tax bracket after retirement, then a Roth conversion will help you avoid taxes on IRA withdrawals.
  • If you estimate a higher tax rate in the future, then a conversion in the present moment means that you can take advantage of current low rates and escape higher taxes on future withdrawals.
  • Some people convert their traditional IRAs into Roth IRAs in retirement to ensure tax-free withdrawals.

How Do You Do a Roth Conversion?

A Roth conversion can be done in the following three ways:

  • Rolling over funds from a traditional IRA into a Roth IRA within 60 days of withdrawal.
  • Requesting the current trustee or financial institution holding your traditional IRA funds to transfer them to a Roth IRA account with a different institution.
  • Requesting transfer of funds between traditional IRA and Roth IRA accounts with the same institution.

A key component of the Roth conversion process is the 5-year rule.

Much like the 5-year rule that allows penalty-free distributions from Roth IRAs, its conversion counterpart rule stipulates the following:

  • You must pay a penalty, if you withdraw the transferred principal from your traditional IRA in less than 5 years.
  • Withdrawals after five years are considered penalty-free.

A corollary to this rule is that you can only withdraw funds in the sequence that you converted them to Roth IRAs.

Another important thing to consider during the Roth conversion process is taxes.

Withdrawals from Roth IRA accounts are tax-free because they are funded with after-tax money, meaning you have already paid taxes before depositing them into the Roth account.

In contrast, traditional IRA accounts are funded with pre-tax money and withdrawals are taxed at ordinary rates.

The IRS recovers taxes on traditional IRA funds during the conversion process.

Here are some other important points to note while making Roth conversions:

  • Don’t forget to fill out a beneficiary form for the new Roth account.
  • Use Form 8606 to report Roth conversions for taxation purposes.
  • If you are already retired and taking RMDs from a traditional IRA account, then you must take all due RMDs for that year before a conversion.

Taxes and Roth Conversions

Roth conversions are taxed at ordinary tax rates.

Therefore, the amount that you withdraw will be added to your overall income for that year and taxed at the prevailing rate.

For example, if you’ve earned $100,000 one year and you withdraw $200,000 from your traditional IRA account for transfer to a Roth account, then your total income for that year will be $300,000.

This means that your tax liabilities will multiply.

A good strategy to save on taxes in this context is to distribute the withdrawal over a number of years.

For example, if you split the $200,000 withdrawal over four years, then your total income for each year would be $150,000, half of the earlier $300,000.

Alternately you can withdraw more in a year when you expect to claim more tax deductions.

Backdoor Roth IRAs

A common strategy used by wealthy individuals to take advantage of Roth IRA is the backdoor Roth IRA.

Roth IRA accounts have income limits in the form of Modified Gross Adjusted Income (MAGI), making individuals who earn above a certain amount ineligible for their benefits.

In 2024, the income limit for individuals is $161,000 and for married couples the limit is $240,000.

The backdoor Roth IRA involves opening traditional IRA accounts, which do not have income limits, and converting the same IRA immediately to a Roth account.

If you have contributed after-tax dollars to the traditional IRA, then your tax liabilities will be significantly lower during the conversion process.

Roth IRA Conversion FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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