Roth IRA Conversion

Converting to a Roth IRA is a very easy and simple process. This article is an overview of the Roth IRA conversion rules and process.

In order to make new contribution to a Roth IRA, income and contribution limits apply. However you can convert some or all of you balance in a Traditional IRA account to a Roth IRA, no Roth IRA conversion income limits apply.

Converting to a Roth IRA from a Traditional IRA is helpful if you expect you tax bracket to be higher in retirement from where it is currently. If you are earning above the income limits for Roth IRA contribution, you can use the conversion process as a backdoor entry to make contribution to Roth IRA and get tax-free income during retirement.

You can also convert other retirement accounts (like 401K and 403b) to Roth IRA. Typically this can only be done once you have left the employer who had sponsored the plan (check with you plan administrator).

When you opt for conversion from a pre-tax account such as Traditional IRA and 401K, you will have to pay taxes on the amount of dollars converted in the tax year during which the conversion takes place. You initial contribution to these pre-tax retirement accounts were tax free, so the IRS want a take a piece now.

Since the amount you convert gets added to your current year income, the amount of taxes you pay will depend on your income in the year the conversion takes place

The conversion makes sense if

  • You expect a higher tax bracket on withdrawal from your pre-tax accounts during your retirement than what you would pay as taxes for converting them now.
  • Your current year’s income is above the Roth IRA income limits for contribution and you expect that your tax bracket will be higher in retirement.
  • The amount you are converting from a pre-tax retirement account will not have any severe impact on your tax bracket or will not cause you to pay taxes on other income sources (for example if you are drawing social security, a conversion from traditional IRA will add to your income for the current year, which may push you in a higher tax bracket), the conversion can be considered.

 Traditional IRA to Roth IRA conversion

If you are going with a new financial institution for the Roth IRA account, go for a trustee-to-trustee transfer. Your new trusty will provide you with all the account details you will have to provide to the one managing your Traditional IRA account.

If you are staying with the same financial institution, you request a conversion of the account to a Roth IRA. It should be as simple as a supervisor re-designating your account.

 401k to Roth IRA conversion

Conversion from a 401k account can be tricky. Be sure to opt for a direct transfer of assets to the financial institution where you will be operating the Roth IRA account. If you opt to take a check in your name, your 401k administrator will hold back 20% for tax purposes. However you have to rollover the entire amount to a Roth IRA (including the 20%) in 60 days or else you will owe taxes on any amount that is not rolled over (if you are younger than 59 1/2 years, you will also owe 10% penalty on the money you withdraw).

Once you have completed the roll over, ensure your assets are invested as per your investment plan. If the same options are not available to you in the Roth IRA, you may have to select suitable alternatives. You are now equipped to convert your accounts to a Roth IRA.

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