Roth IRA Conversion: Rules, What to Know

What is a Roth IRA conversion? ​​

A Roth IRA conversion is the process of transferring funds from a pretax retirement account, such as a traditional IRA or an employer plan, into a Roth IRA. The conversion requires paying taxes on the funds in the year they’re transferred, but future growth and withdrawals will be tax-free.

Roth conversions are often done to take advantage of Roth benefits such as no required minimum distributions and the ability to withdraw conversions after five years without taxes. This flexibility allows people to optimize their retirement savings and goals for their specific needs.

If you already have a traditional IRA, there's a good chance you can open a Roth with the same institution. But if you still need to open an account, here's how to open a Roth IRA.

How to complete a Roth conversion

To stay in sync with IRS rules, you must follow specific steps. Here are three options for converting a traditional IRA to a Roth IRA.

1. Indirect rollover: You receive a distribution from a traditional IRA and contribute it to a Roth IRA within 60 days.

2. Trustee-to-trustee or direct rollover: You tell the financial institution holding your traditional IRA assets to transfer an amount directly to the trustee of your Roth IRA at a different financial institution.

3. Same-trustee transfer: If your traditional and Roth IRAs are maintained at the same financial institution, you can tell the trustee to transfer an amount from your traditional IRA to your Roth IRA.

People who make too much income to directly contribute to a Roth can still convert money from a traditional IRA to a Roth IRA through a process also known as a backdoor Roth IRA.

When it comes to converting funds from a 401(k) plan to a Roth IRA, that process is called a mega backdoor Roth.

You may also be able to do a rollover of a 401(k), 403(b) or other employer-sponsored retirement fund to a Roth if you are no longer working for the company, but as with the traditional-IRA-to-Roth rollover, you’re likely to trigger a tax bill here, too, unless you’re starting with a Roth 401(k).

» Ready to get started? See our picks for the best Roth IRA providers.

Roth conversion rules: Factors to consider

Before taking on a Roth conversion, it’s important to weigh several key factors to determine how it could impact you financially, both in the present and future.

Taxes. A Roth conversion can spell additional tax obligations in the year the conversion takes place. That’s because you’ll need to “give back” any tax deductions you took on your traditional IRA contributions. Therefore, the amount that you convert from a traditional IRA, as well as any earnings, will be taxed as ordinary income. Depending on the amount you plan to convert, this could push you into a higher tax bracket. That higher income could also affect Medicare premiums or Social Security taxes.

Five-year withdrawal rule. If you are under age 59 ½, your Roth conversions and earnings must stay in the account for five years before they can be withdrawn tax- and penalty-free. If you withdraw too early, this can result in taxes and penalties of up to 10%, and the rule applies to every conversion you make. (Learn more about how the five-year rule for Roth IRAs works.)

No recharacterizations. Once you’ve made a Roth IRA conversion, you’re not able to move the money back into a different retirement account.

No required minimum distributions. The IRS mandates that RMDs from a traditional IRA start at age 75 unless you were born before January 1, 1960, in which case RMDs begin at age 73. Roth IRAs don’t have RMDs, which means you aren’t required to make withdrawals after a certain age.

No income limits. While contributing directly to a Roth IRA depends on your modified adjusted gross income (MAGI), anyone can complete a Roth conversion and keep adding to the account via future conversions.

» Learn more about Roth IRA contribution and income limits.

Benefits and drawbacks of a Roth conversion

A Roth IRA conversion could be right for you if...

• You like the idea of your investment earnings growing tax-free.

• You want the ability to lower your taxable income in retirement.

• You think your tax rate in retirement may be higher than it is now.

• You want to avoid required minimum distributions. 

» Discover how much you could save in taxes using our Roth IRA calculator.

A Roth IRA conversion might be wrong for you if...

• You lack the cash to pay the likely tax bill generated by the conversion, or you may need to pay the tax bill with part of the converted amount, as it would sacrifice some of the tax-free investment growth.

• You need the money in the next five years. 

• The rollover will subject you to a higher marginal tax bracket in the year of the switch.

• You want to avoid being moved into higher Medicare premiums.

Strategies to minimize taxes on a Roth conversion

You can't necessarily avoid taxes altogether when doing a Roth conversion, but you can reduce the amount of taxes you owe on the rollover. Consider timing it in one of these ways:

• Convert in low-income years. Maybe you switched jobs, had a period of unemployment, or didn’t qualify for your usual bonus. Being in a lower tax bracket reduces the cost of the conversion.

• Convert during years of high inflation. If the market takes a hit and your IRA feels the aftershock, that could be an opportune time to launch this strategy. Timing your conversion well means you could pay taxes on a smaller amount, and allow the money to potentially rebound in a Roth IRA, where it can be withdrawn tax-free.

• Convert early in the tax year. Taxes don’t have to be paid in full until the filing deadline (usually in mid-April the following year), so converting early in the calendar year gives you more time to pay Uncle Sam. (If you pay estimated taxes, you might have to make payments sooner.)

• Spread conversions over multiple years, as you can afford to pay the taxes. You do not have to convert your full balance all in one go. (This strategy of pacing out conversions annually is called a Roth conversion ladder.) You can’t, however, only convert the portion of your balance that wouldn’t be taxed, such as nondeductible contributions.

The bottom line

Roth IRA conversions offer a strategic way to turn taxable retirement savings into tax-free income in the future. The process involves transferring funds from a traditional IRA or other retirement account into a Roth IRA, allowing for advantages such as tax-free growth, no required minimum distributions and the opportunity to leave a tax-free inheritance to heirs.

When considering a Roth IRA conversion, taking into account your future and present circumstances is key. Review your tax situation and future expectations, the five-year rule and overall financial goals to see how a Roth conversion could fit into your retirement strategy.

Frequently asked questions