Answers to Roth conversion questions

Learn about Roth conversion taxes.

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Key takeaways

  • There are pros and cons to converting early in the year vs. later.
  • Your tax liability depends on whether you're converting pretax or after-tax money.
  • If you are over age 70½, you will need to take a required minimum distribution (RMD) the year you convert.
  • The tax reform bill that passed in December 2017 eliminated the ability to recharacterize Roth conversions for taxable years after 2017.

Who wouldn't want tax-free growth potential and tax-free withdrawals in retirement? That's what a Roth IRA can offer.

However, because of IRS-imposed income limits, not everyone can contribute to one. But you still may be able to benefit from a Roth IRA's tax-free growth potential and tax-free withdrawals by converting existing money in a traditional IRA or other retirement savings account.* And some people may prefer to convert, even if they are not eligible to contribute. Either way, here are some answers to common questions on Roth conversions.

Section 1: Roth conversion basics

Does time of year matter?

Converting earlier in the year generally provides more flexibility than converting later.

  • More time to pay the tax. Taxes aren't due until April 15 of the following year, so you may have more than 15 months to pay the taxes on your converted balances. (Note: If you pay estimated taxes, you may need to make some payments sooner.)
  • You have the option to undo 2017 Roth conversions until the tax filing deadline plus extensions—which is October 15, 2018. Due to tax law changes, conversions done in 2018 or beyond are no longer eligible to be undone.

Converting later in the year also has several benefits, and of course its own disadvantages.

  • Pro: Take advantage of the conversion 5-year rule. You'll pay a 10% penalty if you make non-qualified withdrawals of converted balances from a Roth IRA within 5 years, but the clock on the 5-year rule for withdrawing converted balances penalty free from a Roth IRA begins in January of the year you convert—no matter when you actually convert. So a conversion made on December 31 is considered the same as a conversion made on January 1 of the same year. In both cases, converted balances are eligible for penalty-free withdrawals beginning January 1, 5 years later. (For earnings, as opposed to converted balances, to be withdrawn without tax or penalty, the withdrawals must be qualified, meaning you must have had at least one Roth account open for at least 5 years and you must satisfy at least one of the other IRS qualified distribution criteria: you reach age 59½, become disabled, make a qualified first-time home purchase, or die.) So if you convert later in the year, you have the potential to access these funds almost a full year sooner than if you converted earlier in the year.
  • Pro: Better information to avoid a change of tax bracket. The closer you are to the end of the year, the more information about your income taxes for the year that you'll have. This may allow you to convert a better targeted amount to ensure that the income from the conversion doesn't bump you into a higher income tax bracket. Because the amount you convert is considered taxable income (assuming there weren't any after-tax contributions), you may want to consider converting no more than what you think will bring you to the top of your current federal income tax bracket.
  • Con: Less time before the taxes come due. The taxes on the amount you converted will be due not long after your conversion.

Can I convert just part of my traditional IRA balances to a Roth IRA?

Yes, you can choose to convert as much or as little as you want of your eligible traditional IRAs. This flexibility enables you to manage the tax cost of your conversion.

For instance, because the amount you convert is generally considered taxable income, you may want to consider converting no more than what you think will bring you to the top of your current federal income tax bracket. You also may want to consider basing your conversion amount on the tax liability you may incur, so you can pay your taxes with cash from a nonretirement account.

Can I convert money from a traditional 401(k) to a Roth IRA?

If you no longer work for the company that offered you a 401(k) plan—whether you are retired or changed jobs—you can convert eligible non-Roth 401(k) money to a Roth IRA in one of 3 ways.

  1. Pretax contributions only. If you have only pretax money in your 401(k), you will need to pay taxes on the entire amount you convert to a Roth IRA.
  2. Both pretax and after-tax contributions. If the 401(k) includes both after and pretax money, the tax treatment and conversion rules are a bit different. According to the IRS, you can roll over after-tax contributions from a 401(k) plan or other workplace retirement plan separately from the pretax contributions—as long as the earnings on the after-tax contributions are also distributed from the plan at the same time.
  3. After-tax contributions only.If you made after-tax contributions to the 401(k), you can roll them directly into a Roth IRA without paying taxes on the after-tax amount, as long as the associated pretax earnings are also distributed from the plan at the same time. Another option: If you or your spouse/domestic partner has high income levels and are not eligible to contribute directly to a Roth IRA, you may want to consider contributing to a traditional IRA and then converting immediately to a Roth IRA. This is commonly known as a "backdoor Roth" strategy. Of course, there are other factors to consider when converting or rolling over pretax money, so consult a tax professional.

Consider this example. Let's say you have $50,000 in after-tax contributions and $50,000 in earnings, for a total of $100,000, in your 401(k) account from your former employer. You want to put some of that money into a Roth IRA. You can roll the $50,000 in after-tax contributions to a Roth IRA and pay no taxes. The earnings would be subject to taxes if you rolled them into the Roth IRA as well, so consider instead rolling the earnings into a traditional IRA, which would not generate any tax liability this year.

Tip: For more detail, see Converting Your Traditional IRA to a Roth IRA which includes a Roth conversion tool and a checklist.

Section 2: Roth conversions and taxes

How can I estimate my tax liability on an IRA conversion?

Your tax liability is based on 2 things: the taxable income generated by the conversion and your applicable tax rate. To determine what portion of your conversion is taxable income, you need to know the types of contributions in all of your non-Roth IRAs (other than inherited IRAs). This is because your contributions to a non-Roth IRA could be either pretax (i.e., you took an income tax deduction when you made the contribution) or after tax (i.e., you did not take an income tax deduction when you made the contribution). Note that earnings on your contributions, whether they're pretax or after-tax, are always considered pretax.

Pretax contributions. Estimating the taxable income from a conversion is straightforward if you've never made after-tax contributions to any non-Roth IRA. If that is the case, whatever amount you convert will be taxable income. It can become a little tricky if you have after-tax contributions in any of your non-Roth IRA accounts.

After-tax contributions. According to IRS rules, you cannot cherry-pick and convert just after-tax contributions (leaving pretax amounts in the account) in your eligible non-Roth IRAs so you won't incur any taxes. Instead, you need to determine the percentage of after-tax contributions across all your non-Roth IRAs. Then use that percentage to determine the portion of the conversion that is not taxable. To calculate this percentage, you need to total both the balances and the after-tax amounts in all non-Roth IRAs in your name, even if they are held at different IRA providers. Important Note: Don't include your spouse's IRAs or any inherited IRAs when doing this. In simpler terms, think of all your non-Roth, non-inherited IRAs as one account.

Let's look at an example (see chart below). Raj has $100,000 eligible for conversion in 2 traditional IRAs. Traditional IRA #1 has $85,000 in pretax contributions and earnings; traditional IRA #2 has $10,000 in after-tax contributions and $5,000 in earnings (treated as pretax), for a total of $15,000. Raj wants to convert $10,000 this year. Ninety percent ($90,000) of the total eligible IRA balance ($100,000) is in pretax contributions and earnings. So his taxable percentage is 90%. For the $10,000 conversion amount, that's $9,000.

Tip: If you and your spouse both have conversion-eligible non-Roth IRAs, you may want to compare your total percentage of pretax contributions and earnings with that of your spouse. Why? If your spouse has IRAs with mostly after-tax contributions and you have IRAs with mostly pretax contributions, you might consider converting your spouse's IRAs before yours to reduce the potential tax impact of conversion.

Section 3: Roth conversions and RMDs

Do I still need to take a required minimum distribution (RMD) in the year I convert if I'm over 70½?

Yes. In general, the first money withdrawn from your account has to satisfy your RMD. Additional withdrawal amounts can be converted to a Roth IRA, which does not require RMDs. That said, money you withdrew to satisfy your RMD (after paying taxes on the RMD itself) could be used to pay the taxes on the conversion.

People age 70½ and older are generally required to take an RMD every year from their tax-deferred retirement accounts (traditional, SEP, rollover, and SIMPLE IRAs, and workplace plan accounts). RMD amounts are not eligible to be converted to a Roth IRA. IRS rules specify that you must satisfy the RMD for the year you convert before initiating a Roth IRA conversion. Converting the RMD amount can result in an excess contribution to the Roth IRA and can trigger possible excise taxes. Instead, you can satisfy your RMD amount for your IRAs from any one or more of your non-Roth IRAs (other than an inherited IRA).

Say, for example, you have a $100,000 traditional IRA with a $7,000 RMD for the current year. If you were to convert the entire balance to a Roth IRA, you'd want to satisfy the RMD first. If you didn't, the $7,000 RMD amount would be considered a contribution to the Roth IRA, not a conversion. In this example, you'd effectively be making a $93,000 conversion and a $7,000 Roth IRA contribution.

But what if you were not eligible to make a Roth IRA contribution of that size because (1) your income was too high, (2) you didn't have enough earned income, or (3) the RMD amount was above the annual Roth IRA contribution limit? (Note that for 2017 and 2018, the contribution limits are $5,500, or $6,500 for those age 50 and up.) In any of those situations, you might be subject to IRS excess contribution penalties, including excise taxes of 6% annually until the excess contribution is corrected.

Tip: To avoid this situation, take your RMD from your traditional IRAs (other than an inherited IRA, which has its own RMD) before converting. If you have already done a conversion in the current tax year but didn't take the RMD, you should speak with your tax adviser.

How does my state tax Roth IRA conversions?

A Roth IRA conversion is a taxable event. If your state has an income tax, the conversion will likely be treated as taxable income by your state, as well as for federal income tax purposes. Because each state's income tax rules are different, however, it makes sense to check with a tax adviser before you convert.

Section 4: Can I reverse a Roth conversion?

Before December 2017 when tax laws changed, you would have had the option to undo the conversion. After tax year 2017 it will no longer be possible. If you converted to a Roth in tax year 2017, you will be able to undo the conversion until the tax filing deadline plus extensions, which is October 15.

Read Viewpoints on Fidelity.com: How to reverse a Roth conversion

Summary

Thanks to Roth IRAs' tax-free growth potential and tax-free withdrawals, most investors should consider having them as part of their overall retirement income plan, especially when after-tax contributions are a high proportion of your total IRA balances. But deciding whether to convert isn't necessarily a straightforward decision. That's why we suggest that you carefully assess your situation and check with a tax adviser to help you make an informed decision.

Next steps to consider

See how to convert to a Roth IRA from a traditional IRA or 401(k).

Know how to take advantage of the potential of a Roth IRA.

Find out how to convert your traditional IRA to a Roth IRA.

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