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Roth IRA Conversion Guide

roth ira conversion

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Roger Wohlner
Updated September 14, 2022
6 Min Read

Roth IRAs can be a good option for investors saving for retirement. Roth IRAs offer tax-free growth and the money in the account can be withdrawn tax-free if certain requirements are met. Roth IRAs are not subject to required minimum distributions and can be advantageous in estate planning due to the inherited IRA rules of the SECURE act. 

Here are some things to know when considering a Roth IRA conversion. 

What is a Roth IRA conversion? 

A Roth IRA conversion involves converting funds held in a traditional IRA to a Roth IRA. This can involve a conversion of the entire traditional IRA or a portion of the traditional IRA. The conversion can be made to an existing Roth IRA or a new Roth IRA can be opened to accept the conversion. 

There are income limitations on the ability to contribute to a Roth IRA that can limit or totally prohibit your ability to make Roth IRA contributions. In addition, annual contribution amounts are limited to the amount allowed for IRAs, which are $6,000 with an additional $1,000 catch-up contribution for those who are 50 over for 2022. 

A Roth IRA conversion is helpful for those who are ineligible to contribute to a Roth IRA due to their income and for those who want to have a larger amount of their retirement savings to be in a Roth account. 

Converting a Traditional IRA to a Roth IRA 

There are several ways to convert a traditional IRA to a Roth IRA.

Perhaps the easiest is a situation where both accounts are at the same custodian, for example Fidelity, Vanguard, Schwab or others. In a case like this you would simply do the conversion at the custodian, often this can be done online by logging into your account. 

Another scenario would be if the conversion is being done from a traditional IRA at one custodian to a Roth IRA at another custodian. In this case you will want to check with each custodian to determine how the process will work. You should be able to do this as a trustee-to-trustee transfer, but each custodian has their own procedures including which custodian would initial the transfer to do the conversion. 

Another route is to take a distribution from a traditional IRA account and then do the conversion by depositing the distribution into a Roth IRA account. Under this methodology you will generally need to complete this transaction within a 60-day timeframe to avoid taxes and any penalties on the distribution. 

Tax Implications of Converting to a Roth IRA 

Money converted from a traditional IRA to a Roth IRA is generally taxable at your marginal federal tax rate for ordinary income. For example, if your income was $100,000 and then you did a Roth IRA conversion of $25,000, then you would have $125,000 of ordinary income. 

Taxation of money converted to a Roth IRA will vary at the state level based on the rules of your state. For example, my home state of Illinois does not tax Roth IRA conversions. It is a good idea to check the rules for your state to be sure. 

If some of the money in your traditional IRA consists of after-tax contributions, then the conversion amount is taxable based on the ratio of money contributed on an after-tax basis to pre-tax contributions and earnings. 

On a longer-term basis, money converted from a traditional IRA to a Roth IRA will not be taxed in the future. In the case of required minimum distributions, the money converted to a Roth IRA will never be part of the RMD calculation in future years. This will result in lower RMDs and lower taxes than if the money had not been converted. 

One strategy surrounding taxes is to look at your income in a given year before doing the conversion. If you have a year when your income is lower than normal, this might be a good time to do the conversion. 

Roth Conversion Limits 

There are currently no limitations on the number of Roth IRA conversions that you can do or on the size of the conversions. You will want to take the tax implications and other factors into consideration in determining the timing and size of any Roth IRA conversions. 

While not a limit per say, for those who must take an RMD from a traditional IRA account, the RMD must be taken in full, doing a Roth IRA conversion does not reduce the amount of the RMD or the taxes due. 

The Build Back Better legislation proposed by Congress, but not yet passed by the Senate, included limitations on Roth IRA conversions by wealthy taxpayers. This may come to pass at some point in the future, but as of now there are no income limitations for Roth IRA conversions. 

Backdoor Roth IRAs 

A backdoor Roth IRA is a technique for those who earn too much to contribute directly to a Roth IRA. With a backdoor Roth, you would make an after-tax contribution to a traditional IRA and then convert that money to a Roth IRA.

If you have no other money in traditional IRA accounts, then the conversion would be tax-free. To the extent that you do have other money in a traditional IRA that consists of pre-tax contributions and earnings on the money in the accounts, then the money converted would be taxable based on the percentage of after-tax contributions to pre-tax contributions and earnings in the accounts in total. 

There was a provision in the Build Back Better legislation to eliminate the ability to do both the backdoor Roth IRA and the mega backdoor Roth, a technique tied to an employer retirement plan. The provision would have eliminated the ability to convert after-tax funds in a retirement plan. To date this legislation has not passed. 

Watch Out for the Five-Year Rule 

When it comes to Roth IRAs, it's important to understand the five-year rule. This rule is important in determining whether a withdrawal from a Roth IRA will be tax-free. 

The five-year rule comes into play with: 

  • Money contributed to Roth IRAs
  • Money converted to a Roth IRA
  • Inherited Roth IRAs 

With money contributed to a Roth IRA, the five-year “clock” starts with the first contribution made to a Roth IRA. This carries over to multiple Roth IRAs if applicable. Once the five-year rule is satisfied, then distributions will be tax and penalty free if you are at least age 59 ½, or under certain other circumstances. 

For Roth IRA conversions, there is a separate five-year rule for money that is converted. Each conversion has its own five-year rule. As far as inherited Roth IRAs, the five-year rule must have been satisfied by the original account owner prior to their death in order for the beneficiaries to be able to take distributions from the inherited Roth IRA tax-free. 

When taking distributions from a Roth IRA, there are ordering rules pertaining as to which dollars come out first. The ordering rules specify that contributions come out first, followed by dollars that were converted in the order in which the conversion occurred with the oldest conversions coming first. After all contribution and conversion dollars are withdrawn, account gains are the last withdrawal tier. 

This can get complicated, so it's important to know the status of each portion of your Roth IRA account relative to the five-year rule to avoid taxes on withdrawals.  


Is there a limit to Roth conversions? 

There are currently no limits on the number of Roth IRA conversions that can be done or the amount of these conversions. You will want to look at the taxes that would be due on the conversion to help determine the amount and the time of any Roth conversion that you are considering. 

Is the Roth conversion going away in 2022? 

At the time this article was written none of the potential legislation that would curtail or eliminate the use of Roth conversions had been passed. Investors considering a Roth conversion, including a backdoor Roth conversion or a mega backdoor Roth should keep a close eye on legislative developments in this area. 

What is the downside of Roth conversion? 

The downside of a Roth conversion are the taxes on the conversion. The taxes need to be paid in the year of the conversion. Before doing the conversion, an investor should analyze whether the potential long-term benefits of the Roth conversion will outweigh the amount of taxes paid today. This might include the benefits of tax-free appreciation, tax diversification of your retirement accounts and a reduction in future RMDs. 

The Bottom Line 

A Roth IRA conversion is a valid financial and retirement planning strategy for many investors. Be sure you review how a Roth conversion fits into your overall financial strategy and that you consider issues such as timing before moving forward.

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