Roth IRA Conversion: Definition And Rules - NerdWallet (2024)

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Roth IRA Conversion: Definition And Rules - NerdWallet? ›

If you don't qualify to contribute, or if you just want to move money from a traditional IRA into a Roth IRA, you can do a Roth IRA conversion. In a conversion, funds are transferred from a traditional IRA or a qualified employer-sponsored retirement plan (such as a 401(k) plan) into a Roth IRA.

You will owe taxes on the money you convert, but you'll be able to take tax-free withdrawals from the Roth IRA in the future. Be aware that withdrawing converted funds within five years of the conversion will trigger a 10% penalty.

By converting to a Roth IRA, you'll have assets that won't be taxed when withdrawn, potentially allowing you to better manage your tax brackets and enable more personalized tax planning during retirement.

A Roth conversion involves transferring pre-tax—often referred to as “traditional”—retirement account funds into a Roth account. Roth accounts are post-tax, meaning that you've already paid income taxes on what you contribute … and won't pay income taxes on those contributions when you withdraw funds later.

Each conversion or rollover you make is subject to a separate five-year waiting period. If you don't wait the requisite five-year period from conversion to withdrawal, you may have to pay a 10% penalty, along with any income taxes owed.

Since a Roth conversion increases taxable income in the conversion year, drawbacks can include a higher tax bracket, more taxes on Social Security benefits, higher Medicare premiums, and lower college financial aid.

However, there are no limits on conversions. A taxpayer with a pre-tax IRA can convert any amount of funds in a year to a Roth IRA. Roth IRAs also are exempt from required minimum distributions (RMDs). These mandatory withdrawals from retirement accounts begin at age 72 and can create a tax burden on affluent retirees.

While there's no way to avoid conversion taxes completely, you can restructure them to make this much more manageable. By staggering out your conversion or timing it for years in which you have low tax liability or portfolio losses, you can reduce the impact of a Roth IRA conversion.

Even when you're close to retirement or already in retirement, opening this special retirement savings vehicle can still make sense under some circ*mstances. There is no age limit to open a Roth IRA, but there are income and contribution limits that investors should be aware of before funding one.

The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.

What is the basis for a Roth conversion? ›

Basis means money you've paid taxes on already. It's not that common, but if you've made non-deductible contributions to a tax-deferred retirement account and you later decide to convert some of that money to a Roth IRA, you won't have to pay taxes on your basis.

You'll owe income tax on the entire amount that you convert from a traditional IRA into a Roth IRA in the year you make the switch. The amount of tax will depend on your income tax bracket and income tax rate—between 10% and 37%. 1 The money you convert is added to your gross income for the tax year.

High-income earners may be able to bypass these restrictions via a back-door Roth conversion strategy. You'll first contribute to a traditional IRA with pre-tax dollars. Then, when the time is right, you'll convert some or all of those funds into a Roth IRA.

There is no limit to the number of conversions you can do, so you may convert smaller amounts over several years.

Understanding Backdoor Roth IRAs

The limits are as follows: For 2023: Between $138,000 and $153,000 for single filers and between $218,000 and $228,000 for joint filers. For 2024: Between $146,000 and $161,000 for single filers and between $230,000 and $240,000 for married couples filing jointly4.

For tax years before 2018, you had until October 15th of the year after making a conversion to reverse it and avoid the related tax liability. Beginning with the 2018 tax year, undoing Roth conversions are no longer permitted.

Bottom Line. At 65 or any age, while parts of your retirement finances remain unsettled, limiting Roth conversions to small chunks spread over years offers flexibility. This balances immediate tax costs against future tax savings for you and your heirs.

Since there are no income eligibility limits for conversions, however, one common strategy is to make a non-deductible contribution to a Traditional IRA then convert it to a Roth IRA.

You'll owe income tax on the entire amount that you convert from a traditional IRA into a Roth IRA in the year you make the switch. The amount of tax will depend on your income tax bracket and income tax rate—between 10% and 37%. 1 The money you convert is added to your gross income for the tax year.

There is no way to avoid paying taxes on a Roth conversion. However, you can lower your tax burden by timing the conversion right. For example, you might convert in a year when your taxable income is lower than it has been.