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 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.*
Either way, here are some answers to common questions on Roth conversions. Always consult a tax advisor about your specific circumstances.
Section 1: Roth conversion basics
Does time of year matter?
Converting later in the year also has several benefits, and of course its own disadvantages.
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. Talk to your tax advisor. 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 to a Roth IRA even if I earn too much to contribute?
If you or your spouse have high income levels and are not eligible to contribute directly to a Roth IRA, and you do not already have a traditional IRA, you may want to consider opening a traditional IRA and making a nondeductible contribution, then converting it to a Roth IRA. This strategy is sometimes called a back-door Roth contribution.
Tip: For more detail, see Converting your traditional IRA to a Roth IRA, which includes a Roth conversion tool and a checklist.
Can I convert money from a traditional 401(k) to a Roth IRA?
If you are eligible for a withdrawal from a 401(k) plan, you can convert eligible non-Roth 401(k) money to a Roth IRA in one of 2 ways.
Consider this hypothetical example: Let's say an investor has $50,000 in after-tax contributions and $50,000 in earnings on those contributions, for a total $100,000 after-tax source balance, in a 401(k) account from their former employer (and assume the plan tracks source balances separately and allows partial withdrawals). The investor wants to roll this into a Roth IRA. They can roll the $50,000 in after-tax contributions to a Roth IRA and pay no taxes, and though the earnings would be subject to taxes if they rolled them into the Roth IRA as well, they could instead roll the earnings into a traditional IRA. That way, they would not generate any tax liability in the year of the conversion.
No matter which conversion strategy you choose, always consult with a tax professional first.
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 deductible (i.e., you took an income tax deduction when you made the contribution) or post-tax (i.e., you did not take an income tax deduction when you made the contribution), or some combination. Note that earnings are always considered deductible, whether they come from deductible or nondeductible contributions.
Deductible contributions. Estimating the taxable income from a conversion is straightforward if you've never made nondeductible contributions to any non-Roth IRA. If that is the case, whatever amount you convert will be taxable income.
Nondeductible contributions. It can become a little tricky if you have nondeductible contributions in any of your non-Roth, non-inherited IRA accounts. According to IRS rules, you cannot cherry-pick and convert just nondeductible contributions (leaving deductible amounts in the account) so you won't incur any taxes. Instead, you need to determine the percentage of nondeductible contributions across all your non-Roth, non-inherited 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 nondeductible amounts in all non-Roth IRAs and non-inherited IRAs in your name, even if they are held at different IRA providers. Important note: Don't include your spouse's IRAs when doing this. In simpler terms, think of all your non-Roth, non-inherited IRAs as one account.
Let's look at a hypothetical example (see chart below). Raj has $100,000 eligible for conversion in 2 traditional IRAs. Traditional IRA #1 has $85,000 in deductible contributions and earnings; traditional IRA #2 has $10,000 in nondeductible contributions and $5,000 in earnings (treated as deductible), for a total of $15,000. Raj wants to convert $10,000 this year. Of the total eligible IRA balance ($100,000), 90% ($90,000) is in deductible contributions and earnings. So his taxable percentage is 90%. For the $10,000 conversion amount, that's $9,000. It doesn’t matter which IRA the money actually comes from—in either case, the percentage is the same.
Tip: If you and your spouse both have conversion-eligible IRAs, you may want to compare your total percentage of deductible contributions and earnings with that of your spouse. Why? If your spouse has IRAs with mostly nondeductible contributions and you have IRAs with mostly deductible 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—for both workplace plans and for traditional IRAs. In general, the first money withdrawn from your account each year has to satisfy your RMD and is not eligible for a rollover or conversion. Additional withdrawal amounts can be converted to a Roth IRA, which does not require RMDs. Inadvertently converting the RMD amount itself can result in an excess contribution to the Roth IRA and can trigger possible excise taxes. Instead, satisfy your RMD amount with a withdrawal from any one or more of your non-Roth, non-inherited IRAs. Note, you can only aggregate RMD distributions for IRAs. You must take your RMD separately from each employer-sponsored plan that you own.
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.
Remember, people age 70½ and older are generally required to take an RMD every year from their retirement accounts (traditional, SEP, rollover, and SIMPLE IRAs, as well as workplace plan accounts). Note that while Roth IRAs are exempt from this, Roth 401(k)s are not. Also, note that inherited retirement accounts have their own rules for RMDs, which differ from those for the original owners.
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 need 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 2018, the contribution limits are $5,500, or $6,500 for those age 50 and up. In 2019, the contribution limit is $6,000 or $7,000 for people over age 50.) In any of those situations, you might be subject to excess IRA contribution penalties of 6% annually until the excess IRA 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 advisor.
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 advisor before you convert.
To convert or not to convert?
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 advisor to help you make an informed decision.
Next steps to consider
Create a source of tax-free retirement income.
See how to convert to a Roth IRA from a traditional IRA or 401(k).
Get even more answers about converting to a Roth IRA.