A Roth conversion moves money from a traditional IRA (or certain workplace plans) into a Roth IRA. You pay income tax now on the converted amount in exchange for tax-free qualified withdrawals later. Since 2010 anyone can convert, regardless of income.
How the tax works
The pre-tax portion of a conversion is added to your taxable income for the year, taxed at ordinary rates. It is not subject to the 10% early-withdrawal penalty when converted. A large conversion can push you into a higher bracket, so many people convert gradually over several years.
If you have made non-deductible contributions, the pro-rata rule applies: the taxable share is based on the proportion of pre-tax money across all your traditional, SEP and SIMPLE IRAs, not just the account you convert. The calculation is done on Form 8606.
The five-year rules
There are two, and they are easy to confuse:
- For earnings. To withdraw Roth earnings tax-free, you must be 59½ or older (or meet another exception) and your first Roth IRA must have been opened at least five tax years earlier.
- For each conversion. If you are under 59½, each converted amount has its own five-year clock. Withdrawing converted money before five years can trigger the 10% penalty, even though the tax was paid at conversion.
No more undo
Before 2018, people could "recharacterise" a conversion, reversing it, for example if the investments fell in value after converting. The Tax Cuts and Jobs Act of 2017 ended that option for conversions made from 2018 onwards. A conversion is now permanent.
When conversions make sense
Common situations include years of unusually low income, such as early retirement before Social Security begins; expecting higher tax rates later; wanting to reduce future required minimum distributions; and wanting to leave tax-free money to heirs. Paying the conversion tax from money outside the IRA usually makes the strategy more effective.
When they may not
If you expect a lower tax rate in retirement, or would have to use IRA money to pay the tax, a conversion may not pay off. Conversions can also affect Medicare premiums and eligibility for some tax credits in the year of conversion.
Sources
General information about the law as it stood when this page was updated, not financial, tax or legal advice. Rules and limits change; check the official source or a qualified adviser before acting.