Roth IRA conversion rules
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Updated 2:48 p.m. UTC Nov. 7, 2023
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Key points
- A conversion allows you to roll funds from a pretax retirement account into a Roth IRA.
- You will generally owe income taxes on the money you convert.
- A conversion might make sense if you earn too much to contribute to a Roth IRA.
The Roth individual retirement account, or IRA, is touted as one of the best retirement savings tools. You can make after-tax contributions that grow tax-free and enjoy tax-free withdrawals in the future. That’s a benefit you’d be hard-pressed to find elsewhere.
But not everyone is eligible to contribute directly to a Roth IRA. And some people take advantage of pretax contributions to a traditional IRA or 401(k), only to wish later that they had opened a Roth IRA instead.
That’s where a Roth IRA conversion comes in. This strategy allows you to move money from a pretax retirement account into a Roth IRA, bypassing income and contribution limits.
“A Roth IRA conversion is one of the principal tax-free pillars I think of when it comes to retiring tax-free,” says Ed de la Rosa, a financial advisor and the founder of Solid Ground Financial.
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What is a Roth IRA conversion?
Unlike Roth IRAs, traditional IRAs and 401(k)s allow you to make pretax contributions. In other words, either the funds are taken from your paycheck before taxes are withheld or your contributions are tax-deductible after the fact. Distributions in retirement are taxed as ordinary income.
A Roth IRA conversion is the process of rolling funds from a pretax retirement account into a Roth IRA. Because traditional IRAs and 401(k)s have different tax advantages than Roth IRAs, this type of rollover requires converting the funds in your retirement account from pretax dollars to after-tax dollars.
Why convert to a Roth IRA?
The primary reason to convert to a Roth IRA is to avoid income taxes on distributions.
As we mentioned above, pretax accounts like traditional IRAs and 401(k)s require that you pay taxes on the money you withdraw in retirement. But because you’ve already paid taxes on your Roth contributions, there’s no additional tax liability.
Depending on your tax bracket now and during retirement, converting to a Roth IRA could save you a lot of money.
“I have yet to meet someone who thinks tax rates are going down,” de la Rosa says. “If tax rates double in the next 10 years and you have as much money as possible in the tax-free bucket, then two times zero is zero.”
Another advantage of having your retirement dollars in a Roth IRA is to avoid required minimum distributions. Pretax retirement accounts require that you start taking RMDs at age 73. And with those RMDs come income taxes.
Once you roll the funds into a Roth IRA, they are protected from RMDs. Thus, a Roth IRA is a popular tool for people who won’t need that money until later in retirement or want to leave it to their heirs.
“You cannot be too old to reap the benefits of a conversation,” de la Rosa says. “A Roth conversion is a fantastic estate planning tool.”
How to convert your traditional IRA to a Roth
Converting your traditional IRA — or other retirement plan — to a Roth IRA is a simple process, assuming you already have a Roth IRA set up. You can complete the rollover using one of the following methods:
- Direct rollover: The plan administrator delivers your distribution to the financial institution where your Roth IRA is held.
- Indirect rollover: The distribution is paid to you, and you have 60 days to deposit the funds in your Roth IRA.
“It is important to know that one does not have to convert the entire traditional IRA,” says Bob Schneider, senior vice president director of financial planning and wealth advisor with Johnson Financial Group. “Many people follow a strategy that has them converting a portion of the traditional IRA dollars each year over a series of years.”
This strategy, known as the Roth conversion ladder, can help you spread out taxation and is popular among people preparing for early retirement.
What can be converted to a Roth IRA?
Many types of retirement plans can be rolled into a Roth IRA, including the following:
- 401(k)s.
- 403(b)s.
- 457(b)s.
- Traditional IRAs.
- SEP IRAs.
- SIMPLE IRAs.
Further, almost any type of distribution can be rolled into a Roth IRA. Exceptions include RMDs and hardship distributions.
Tax considerations when converting
Converting a traditional IRA or 401(k) to a Roth IRA can be a smart long-term move. But there are potential tax implications.
Because traditional IRAs and 401(k)s are funded with pretax dollars, you’ll generally owe income taxes on that money when you roll it into a Roth IRA, which is funded with after-tax dollars. The amount you’ll pay depends on your marginal tax bracket.
Note: Depending on how much you convert, you might find yourself in a higher marginal tax bracket because of this additional taxable income.
“The taxes due will reduce the size of the IRA if paid from IRA dollars,” Schneider says. “Roth conversion generally works better if the tax is paid from outside of the IRA, thus maximizing the amount that is converted. Either way, the tax payment reduces the balance sheet, and it will take a while to earn that back through tax-deferred growth.”
A possible exception is what’s known as a backdoor Roth IRA, which allows you to fund a Roth IRA even if your income exceeds the limit set by the IRS. In this case, you contribute money to a traditional IRA and then immediately convert it to a Roth IRA — before you take a tax deduction and before any earnings have been generated.
Beware of the five-year rule
Roth IRAs are subject to a five-year rule that says you generally cannot withdraw your earnings unless it has been five years since you contributed to your first Roth IRA.
But the five-year rule for Roth IRA conversions is different. Each conversion is subject to its own five-year holding period. If you withdraw funds before those five years are up, you could face a 10% early withdrawal penalty.
Should you convert to a Roth IRA?
A Roth IRA conversion is a popular investment strategy that allows people to make tax-free withdrawals during retirement. There are several situations where a Roth IRA conversion might make sense.
First, a Roth IRA conversion could be a good choice if you expect to be in a higher tax bracket during retirement than you are today.
Jamieson Hopp, a certified financial planner with Millennial Wealth, provides the following example.
Let’s say you are retired at age 62 and are not taking Social Security yet. You know you will have required minimum distributions starting at age 73 via your traditional IRA. Because RMDs and Social Security payments will increase your income at age 73, you convert some of your traditional IRA now and pay taxes on those funds, allowing them to grow tax-free until you need them in retirement.
Another situation where a conversion might be worthwhile is if your income is too high to contribute to a Roth IRA directly. To max out your Roth IRA contribution in 2024, your income must be:
- Less than $146,000 if you are a single filer.
- Less than $230,000 if you are married filing jointly or a qualifying widower.
By using the backdoor strategy we mentioned above, you might be able to fund a Roth IRA and avoid the tax implications of a conversion down the road.
“This allows you to make a nondeductible IRA contribution to your traditional IRA and convert it to your Roth IRA tax-free,” Hopp says. “This is because you did not take a deduction from your original traditional IRA contribution.”
A Roth conversion also might be a good idea if you plan to retire early. If you wait five years after each Roth IRA conversion, you can withdraw the converted amount tax- and penalty-free.
Many early retirees use the Roth conversion ladder strategy we mentioned above. In this case, you do a Roth IRA conversion each year in the five years before you need to tap your retirement funds. Then, starting five years later, you take a Roth IRA distribution each year in the amount you converted five years earlier.
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Frequently asked questions (FAQs)
There’s no limit to how much you can convert to a Roth IRA. The $7,000 annual contribution limit — $8,000 if you’re age 50 or older — that applies to Roth IRAs doesn’t apply to conversions. But it could be in your best interest to spread out your conversions over several years to limit your tax liability.
The major benefit of converting money to a Roth IRA is that you’ll generally be able to withdraw it tax-free during retirement. The biggest downside is the tax bill you might incur in the process. Your individual situation determines whether a conversion makes sense for you.
There’s no penalty for converting to a Roth IRA. But you generally will owe income taxes when you convert a pretax retirement plan like a traditional IRA or 401(k) to an after-tax retirement plan like a Roth IRA. And any withdrawal that runs afoul of the five-year rule will be subject to a 10% penalty.
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