Advertiser Disclosure

How a Roth IRA Conversion Works

A Roth conversion turns a traditional IRA into a Roth IRA, which may have long-term tax benefits if you expect to be in a higher tax bracket in retirement.
Investing, IRA, Retirement Planning, Roth IRA
how a Roth IRA conversion works

There are a lot of reasons to consider a Roth IRA conversion, which shifts money from a traditional IRA into a Roth IRA.

Whether you picked the wrong retirement account at the outset or simply have too much income to otherwise qualify for a Roth, a conversion can be a smart move in some situations. Here’s when you might consider a conversion and what you will need to convert an existing retirement account into a Roth.

Is a Roth conversion right for you?

Generally, a Roth IRA is an excellent choice when any of the following situations apply:

  • When you anticipate your tax rate in retirement will be higher than your current bracket
  • When you want to avoid required minimum distributions, which the IRS mandates at age 70½ from a traditional IRA
  • When you want to continue adding to your account after age 70½, which is prohibited with traditional IRAs
  • When you want the ability to lower your taxable income in retirement

And there are some instances in which a Roth conversion may be more trouble than it’s worth:

  • If you lack the cash to pay the likely tax bill generated by the conversion. Some people pay the tax bill with part of the converted balance, but that sacrifices some of the tax-free investment growth. And if you’re under 59½, you may open yourself up to a 10% tax penalty on that money.
  • If you need the money in the next five years. Distributions of earnings and rolled-over amounts risk being hit with income taxes and even that 10% penalty from the IRS if they’re withdrawn before the five-year mark. Learn more about the Roth five-year rules if you fall into this category.
  • If the conversion will subject you to a higher marginal tax bracket the year of the switch, that increase may make the strategy less attractive in some cases.

» Know the basics: What is a Roth IRA?

How to convert to a Roth in 3 steps

Here are the essential steps in a Roth conversion. You can skip step 1 if you already have a traditional IRA.

  1. Put money in a traditional IRA account. If you don’t already have an account, you will need to open one and fund it. (See our picks for the best traditional IRA providers.)

2. Pay taxes on the contributions and gains to your traditional IRA. Only post-tax dollars get to go into Roth IRAs. So if you deducted your traditional IRA contributions, you’ll need to give that tax deduction back, effectively. Also, if the money in your existing traditional IRA produced any gains, you’ll need to pay taxes on those as well.

3. Convert the account to a Roth IRA. If you don’t already have a Roth IRA, you’ll open a new account during the conversion. Your IRA administrator will give you the instructions and paperwork. (See our list of the best Roth IRA accounts.)

Only post-tax dollars get to go into Roth IRAs. So if you deducted your traditional IRA contributions, you’ll need to give that tax deduction back, effectively.

To stay in sync with IRS rules, you’ll want to convert your traditional IRA to a Roth IRA in one of the following ways:

  • Rollover: You receive a distribution from a traditional IRA and contribute it to a Roth IRA within 60 days.
  • Trustee-to-trustee transfer: 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.
  • 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.

You may be able to convert a 401(k), 403(b) or other employer-sponsored retirement funds 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).

Timing your Roth conversion

To reduce the taxes you’ll owe on the conversion, consider timing it in one of these ways:

  • In a year you fall in a lower tax rate than normal. Maybe you switched jobs, had a period of unemployment or didn’t qualify for your usual bonus.
  • When your traditional IRA account balance is down. If the market takes a hit and your IRA feels the aftershock, that could be an opportune time to launch this strategy.
  • Early in the tax year. Taxes don’t have to be paid until April the following year, so converting early in the calendar year gives you more time to pay Uncle Sam.
  • Bit by bit, as you can afford to pay the taxes. You do not have to convert your full balance. (You can’t, however, convert only the portion of your balance that wouldn’t be taxed, like nondeductible contributions. The IRS is on to that strategy.)

Getting help with a Roth conversion

Feeling a little overwhelmed? It may make sense to get help from a financial advisor with your Roth conversion if you are:

  • Transferring a large amount of money
  • Planning a series of five-year conversions
  • Converting from an account that includes both deductible and nondeductible contributions

Otherwise, the provider that will handle your new Roth can likely help guide you through the process.

About the authors