What to Know about Roth IRA Conversion’s (2024)

FAQs

What do you need to know about a Roth conversion? ›

A conversion may lead to more taxes

You're recognizing that contribution as income, and you must pay taxes on it – the taxes you didn't pay when it went into the traditional account with pre-tax dollars. If you convert a Roth 401(k) into a Roth IRA, you skip the tax hit, because they're both after-tax accounts.

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.

The five-year rule could foil your withdrawal plans if you don't know about it ahead of time. This rule for Roth IRA distributions stipulates that five years must pass after the tax year of your first Roth IRA contribution before you can withdraw the earnings in the account tax-free.

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.

You can convert an IRA to a Roth no matter how old you are. But if the conversion boosts your income, it could have taxing consequences. You can't contribute to a traditional IRA, at any age, if you don't have earned income.

Taxes aren't due until the tax deadline of the following year, so you may have more than 15 months to pay the taxes on your converted balances. (Note: If you pay estimated taxes, you may need to make some payments sooner.)

Bottom line. Any money moved from a traditional retirement account to a Roth IRA is considered ordinary income and will be taxed. Be prepared to pay the tax bill.

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

Do Roth conversions affect Medicare premiums? ›

Roth conversions require you to understand the potential effect it has on your Medicare premiums. When funds are converted, the IRS sees this as income that has come out of the traditional IRA, which can raise your MAGI past a certain level, thereby increasing the premiums you pay for Medicare B and D.

The government sees RMDs as money you should pay taxes on, so you can't directly convert it into the Roth IRA savings like you can with the other money. However, once the post-taxed RMD money hits your bank account, you are free to invest that money as you wish within the Roth IRA guidelines.

A Roth conversion may be of interest if you: Expect your tax rate to be higher in the future. Are interested in diversifying your assets based on tax status. Plan to keep the money invested for at least five years after the conversion before taking a withdrawal.