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Converting a Traditional IRA to a Roth IRA

IRAs are great funding vehicles for your retirement, and there are a variety of different kinds that can serve you. Traditional IRAs, which grow tax-deferred, are common because they allow your retirement funds to grow more quickly. On the other hand, if you’d like to avoid paying taxes during your retirement, Roth IRAs may be the best option.

The IRS places several restrictions on IRAs (all contributions have to be earned income and there is a limit on how much you can contribute). In addition, the IRS has income thresholds limiting who can contribute to a Roth IRA. For example, a married couple with a modified adjusted gross income (MAGI) over $196,000 a year cannot contribute the full limit and a couple earning more than $206,000 are not eligible to contribute to a Roth IRA.

However, there are no restrictions about converting a traditional IRA into a Roth IRA, also known as a backdoor Roth IRA conversion. Here’s what you need to know if you’re considering converting a traditional IRA to a Roth IRA.

Pros: The Benefits of Converting Your Traditional IRA to a Roth IRA

The primary difference between a traditional IRA and a Roth IRA is when taxes are paid. When you convert a traditional IRA to a Roth IRA, you pay taxes on all the assets that are converted. That means you won’t owe taxes on your withdrawals. The idea is that your money will continue to grow in your Roth account, so you are avoiding taxes on that growth.

Converting a traditional IRA to a Roth IRA is good if you have significant assets in a traditional IRA and you think that your tax liability will be higher when you plan to withdraw the money.

Roth IRAs do not require you to take required minimum distributions (RMDs) each year. Other types or retirement accounts require these RMDs starting when you reach age 72 (age 70 ½ if you reached that age before 2020). This makes Roth IRAs especially attractive if you want to leave those assets to your heirs or just let your money grow for longer.

Cons: The Downsides of Converting Your Traditional IRA to a Roth IRA

You will have to pay the tax bill on all the converted funds. If possible, you should not use any of the money from your IRA to do this. If you are younger than 59 ½ and keep out some of your withdrawal to pay these taxes you could face a 10% penalty. While paying taxes on a conversion may save you money if your account grows, what you pay in taxes is money that could have helped accelerate your account growth.

There are a few ways to carry out a traditional IRA to Roth IRA conversion, but doing it incorrectly can result in tax implications and penalty fees.

There is a five-year holding period on accessing money that was part of a Roth conversion, so unless you are willing to pay a fine that money will be inaccessible for a few years.

All or some of the money you convert can be considered income by the IRS, so if you are near the upper limit of your current tax bracket you should think carefully about when to convert — or plan to convert just a portion of your traditional IRA into a Roth IRA each year. It will also be reported as income on the FAFSA if you have children attending college, which could impact their access to financial aid.

Roth IRA Conversion FAQs

How do I convert a traditional IRA to a Roth IRA?

There are three ways you can do this conversion.

  1. Rollover: You can take a distribution check from your traditional IRA and deposit that money into a Roth account. You must deposit it within 60 days or you could be hit with a penalty tax (in addition to the taxes you owe on the conversion).
  2. Trustee-to-trustee transfer: You can tell the financial institution that holds your traditional IRA to transfer your assets to your Roth IRA account at a different institution.
  3. Same-trustee transfer: You can tell the financial institution that holds your traditional IRA to transfer your assets to a Roth account within the same institution.

How much can you convert from a traditional IRA to a Roth IRA?

You can convert any amount to a Roth IRA, but keep in mind that you will have to pay taxes on that money. You should have enough non-retirement earmarked funds to pay for those. If you can’t cover the taxes for all the money in your traditional IRA, consider spreading your conversion over a few years.

You should also consider your tax bracket when converting and talk to your advisor about whether a conversion will move you to a higher tax bracket.

When can I convert a traditional IRA to a Roth IRA?

You can convert a traditional IRA to a Roth IRA at any time. However, you may want to talk with your financial advisor and determine the best timing. For example, you may want to carry out your conversion:

  • When you have a lower than average tax rate. Perhaps you changed jobs, were unemployed for a time, or didn’t qualify for a bonus. If any of those circumstances dropped you into a lower tax bracket than you normally are, it would be a good year to convert your IRA.
  • When your traditional IRA account balance is low. If the market hasn’t been good to your account, it may be the perfect time to convert those funds because you’ll pay less in taxes.
  • Early in the year. You have until April of the following year to pay taxes, so converting early in the year gives you more time to spread out payments on your tax liability.

Is a traditional IRA conversion to Roth taxable?

Yes, you will need to pay taxes on the funds that are converted from a traditional IRA to a Roth IRA. However, you can make a charitable donation from your IRA funds to help offset some of your tax liability.

Can I do a Roth conversion if I’m retired?

Being retired does not preclude you from converting a traditional IRA to a Roth IRA. However, you can’t access the money for five years, so make sure you don’t need the money in the near future if you plan to convert to a Roth IRA.

If you have questions about the best way to plan for retirement, whether that includes an IRA conversion or not, talk with a financial advisor about your options.