A Roth IRA is one of the most tax-advantaged retirement plans available to individual income earners. Its biggest benefits are that you can withdraw your contributions at any age without taxes or penalties, and all withdrawals in retirement (both contributions and earnings) are also completely tax-free.

What this means: Let’s say you contributed $10,000 into a Roth IRA and due to fortunate investments, it grows to a value of $10 million. With a non-Roth retirement plan, you would have to pay ordinary income taxes when you withdraw the $10 million from your account. With a Roth IRA, the entire amount can be withdrawn with zero money owed in taxes to the IRS.

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What is a Roth conversion?

A Roth conversion is when you transfer the retirement assets from a pre-tax retirement account to a Roth IRA.

Pre-tax retirement accounts can include:

A pre-tax retirement account is funded differently than a Roth retirement account

Pre-tax retirement accounts are funded with pre-tax income, and you receive a tax-deduction for the years you make contributions. Investments in the account grow tax-deferred, and because you contributed with pre-tax income, you’re required to pay ordinary income taxes when you take withdrawals in retirement.

Roth retirement accounts are funded with post-tax income. You don’t get any tax-deductions when you contribute, but withdrawals in retirement are 100% tax-free.

Also read: Roth IRA Vs Traditional IRA: Key Differences & Similarities

How a Roth conversion works

A Roth conversion can be done through a rollover or transfer using the following methods.

Method #1: Trustee-to-trustee transfer 

A trustee-to-trustee transfer can be done when you’re moving assets between the same types of retirement plans. Therefore, in this case, it’s only applicable when converting a traditional IRA to a Roth IRA, since they’re both the same type of individual retirement accounts. 

In a trustee-to-trustee transfer, the assets are sent directly from your traditional IRA custodian to your Roth IRA custodian. If both custodians are the same, it would be considered as a same-trustee transfer.

Also read: Transfer Vs Rollover: What’s The Difference?

Method #2: Direct rollover

If the two retirement accounts are not the same type (ex. converting a 401k to Roth IRA) then a rollover would be required. In a direct rollover, the plan administrator sends the funds directly to your Roth IRA custodian. You never touch the funds.

Method #3: In-direct rollover

In an indirect-rollover (also known as a 60-day rollover), rather than your plan administrator sending the funds directly to your Roth IRA custodian, they’ll send you the funds instead. Once you receive the funds, you’re given 60 days to deposit the full amount into your Roth IRA. During the 60 days, you’re allowed to use the funds for whatever you like, essentially acting as a short-term loan.

The downside of a 60-day rollover is that you don’t get sent all of the funds that you’re rolling over. Your old plan provider will withhold 20% of the funds for a 401k rollover and 10% of the funds for an IRA rollover. It’s up to you to come up with the withheld amount on your own from other sources, in order to deposit the amount in full by the deadline. If you successfully deposit the full amount by the 60-day due date, the IRS will give you back the withheld amount in the form of tax credit the year after the rollover took place.

Also read: Key Differences Between Direct And Indirect Rollovers

Taxes for Roth conversions

Because you’re moving funds from a pre-tax account to a Roth account, you’ll have to pay income taxes on the amount of the conversion. In other words, the amount that you’re converting gets added to your taxable income the year you’re executing the transfer.

The amount in taxes you’ll have to pay depends on your tax bracket and tax rates at the time of the conversion.

Penalties for Roth conversions

With a trustee-to-trustee transfer and direct rollover, there is no possibility of early distribution penalties since you never actually touch the funds during the process. However, with an in-direct rollover, if you fail to deposit the full amount of funds before the 60-day deadline, it would get treated as an early distribution (if you’re under the age of 59½) and you’ll be subject to a 10% early distribution penalty in addition to income taxes.

Who is eligible to do a Roth conversion?

Anyone can do a Roth IRA conversion regardless of their income or marital status. Roth IRA income limits only apply to contributions, and not rollovers, and there are no other income requirements or restrictions. As long as you have a Roth IRA, you can move assets to it from a pre-tax retirement plan through a conversion.

Benefits of a Roth conversion

Why go through the trouble (and taxes) of doing a Roth conversion in the first place? 

Here are a few reasons why a Roth IRA conversion might make financial sense.

  1. Tax-free withdrawals in retirement: With a Roth IRA, you get tax-free withdrawals in retirement, no matter how large the earnings in your account may be. Because you pay taxes on your contributions, there are no tax liabilities when you want to take the money out. This can be especially advantageous if you expect to be in a higher tax bracket in retirement.
  2. No RMD: A Roth IRA has no required minimum distributions (also referred to as RMDs). With other retirement plans, you’re required to start taking distributions from your account starting at the age of 73. Not only does this mean you can keep your money compounding tax-free longer, it also means you won’t be burdened with higher taxable incomes with required distributions added on top.
  3. Estate planning: The assets in your Roth IRA can be passed on tax-free to your beneficiaries. They would be required to withdraw all the funds from the account in 10 years after receiving it, but all withdrawals would be tax-free.

Also read: Benefits & Tax Advantages Of A Roth IRA

When does a Roth conversion make sense?

Everyone’s financial situation is different, and even though a Roth conversion may sound advantageous, there are a few considerations before making the jump.

A Roth IRA conversion might make sense if:

  • You expect to be in a higher tax bracket in retirement. Essentially, you’re getting taxes out of the way now, so that you can enjoy tax-free withdrawals when you’re at a higher tax bracket in the future.
  • You are financially comfortable where you can afford the Roth conversion taxes.
  • You want to pass on your assets to your beneficiaries.
  • You won’t need to withdraw any converted funds from your Roth IRA for the next 5 years. After the Roth IRA conversion, you’re required to wait at least 5 years before you can start taking distributions from the account without the 10% penalty. Additionally, since you get tax-free withdrawals, it’s usually more beneficial to keep your money compounding for as long as possible.

A Roth conversion can be done in any tax year. It may not make sense to do if the taxable income added from the Roth conversion will push you into a higher tax bracket. If that’s the case, it may make more sense to do the conversion when your income is lower.

How to do a Roth IRA conversion

Performing a Roth IRA conversion is simple, especially if you’re not going to be using an in-direct rollover as your transfer method.

  1. Open a Roth IRA. You can open a Roth IRA at any financial institution that offers one, or open an Carry Roth IRA in under 10 minutes.
  2. Let your plan administrator know for both the old and new plans that you want to make the conversion. They’ll provide you with the required paperwork.
  3. Submit the required paperwork and let the administrators handle the transfer.

If you’re using an in-direct rollover, the process is mostly the same. The administrator of your old plan that’s getting transferred will just send you the money first, so you’ll be responsible for depositing the money in full to your new Roth IRA before the 60-day deadline.

Examples of Roth conversions

Traditional IRA to Roth IRA: This is the most common type of Roth conversion. You can convert funds from a traditional IRA to a Roth IRA by paying taxes on the pre-tax contributions and earnings in the traditional IRA.

401k to Roth IRA: If you leave a job and have a 401k with your previous employer, you may choose to convert it to a Roth IRA. Converted funds from a pre-tax 401k account will be taxed as ordinary income. If you also have a Roth 401k account, you can roll it over to a Roth IRA without taxes.

Inherited IRA to Roth IRA: If you inherit a traditional IRA from a deceased person, you have the option to convert it to a Roth IRA. However, you’ll need to pay taxes on the pre-tax contributions and earnings in the inherited IRA during the conversion.

SEP IRA to Roth IRA: If you have a Simplified Employee Pension (SEP) IRA and want to enjoy the tax-free growth potential of a Roth IRA, you can convert your SEP IRA to a Roth IRA. Again, taxes will be due on the pre-tax contributions and earnings.

Simple IRA to Roth IRA: Similarly, if you have a Savings Incentive Match Plan for Employees (SIMPLE) IRA, you can convert it to a Roth IRA by paying taxes on the pre-tax contributions and earnings.

457b to Roth IRA: If you have a 457b retirement plan, which is typically available to government employees and some non-profit workers, you may be eligible to convert it to a Roth IRA. Taxes will be owed on the pre-tax contributions and earnings during the conversion.

403b to Roth IRA: A 403b is a retirement plan typically offered to employees of public schools, tax-exempt organizations, and certain ministers. It can also be converted to a Roth IRA, paying taxes on the pre-tax contributions and earnings.

Frequently asked questions around Roth conversions

When is the Roth conversion deadline each year? 

The deadline to do a Roth conversion is December 31st of each year.

Is there a limit to how much I can convert?

No, there is no limit on how much you can rollover and any rollovers do not affect your contribution limits. For example, you could do a Roth conversion of $50,000 from your 401k to your Roth IRA and still have the full Roth IRA contribution limit available.

What if I’m not eligible for Roth IRA contributions because my income exceeds the income limits?

A Roth IRA has income limits that prevent high income earners from making contributions. For 2023, the income limit is set at $153,000. The good news is that income limits only apply to contributions, and not rollovers.

What retirement accounts can I convert to my Roth IRA?

You can do a Roth conversion for a traditional IRA, SEP IRA, SIMPLE IRA, and qualified employer sponsored retirement plans (QRP) like a 401k, 403b, and 457b.

Do I have to convert the entire amount?

No, a Roth conversion doesn’t require your entire account balance to be transferred. You can choose how much you want to convert. This allows you to convert amounts based on your taxable income each year, increasing conversions for years your income is lower, and decreasing or skipping conversions when your income is higher.

How much in taxes will I have to pay for a Roth conversion?

The converted amount gets added to your taxable income for the year. The amount in taxes you’ll have to pay depends on your tax bracket and tax rates in the year of the conversion.

If I change my mind, can I undo the conversion? 

No, a Roth conversion cannot be recharacterized.

When can I start taking tax-free withdrawals from my Roth IRA?

You can start taking tax-free withdrawals from your Roth IRA once the account is at least 5 years old, and you’re at least 59½ years of age.