IRA Conversion to Roth: Rules to Convert an IRA or 401(k) to a Roth IRA
An IRA conversion to Roth can give you a leg-up in retirement with tax-free income. But proceed with caution.
An IRA conversion to a Roth IRA is a popular pre-retirement or early-retirement move. Roth IRAs offer several benefits that traditional retirement plans don’t. Not only are investment gains in a Roth IRA tax-free, but withdrawals are tax-free, as well.
Just as important, Roth IRAs don’t require savers to take required minimum distributions (RMDs), as traditional IRAs and 401(k)s do. This lets Roth IRA holders benefit from tax-free growth indefinitely and use their retirement accounts to pass wealth on to younger generations. (Thanks to SECURE Act 2.0, Roth 401(k)s also no longer require RMDs as of 2024.)
However, because higher earners can't make direct contributions to a Roth IRA, some people need to convert a traditional IRA or 401(k) to a Roth IRA after the fact. The process is fairly simple, but it’s essential to time those conversions correctly.
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IRA conversion to Roth from traditional accounts
If you have a traditional IRA, converting it to a Roth IRA is straightforward: Contact the financial institution holding the account and complete the required paperwork.
With a 401(k), things could get a touch more complicated.
Many 401(k) plans allow direct rollovers to a Roth IRA. This method involves a trustee-to-trustee rollover and is the best route to take, if available.
If your work doesn't allow rollovers, you'll have to receive a check from your 401(k) (any amount you choose) and roll the funds into a traditional IRA within 60 days. Once you fund your traditional IRA, you can initiate a Roth conversion.
But a word of caution: Your employer must withhold 20% of that check for taxes. To complete the rollover without penalty, you must replace that missing 20% out of your own pocket within the 60-day window.
Another option, if you have a 401(k), might involve an "in-plan conversion," which means converting your traditional employer retirement plan to a Roth 401(k), then moving those funds into an IRA.
A Roth IRA conversion is a taxable event. The amount you move triggers a tax bill for the year you make the conversion, so you'll need to plan ahead for these taxes.
Each conversion carries its own five-year waiting period before you can withdraw converted principal without a 10% early withdrawal penalty (if you are under age 59½). Turning 59½ eliminates this penalty entirely. However, to withdraw any earnings completely tax- and penalty-free, your Roth IRA account itself must have been open for at least five years.
Who benefits from a Roth IRA conversion?
People who expect to be in a higher tax bracket in retirement than during their working years can commonly benefit from a Roth IRA conversion. But there’s more to the story.
Bryan Bell, CFP, ChFC, a vice president, senior investment adviser and regional director at First Horizon, says Roth conversions can be especially useful for people in cyclical industries.
"Mortgage brokers and real estate agents, for instance, tend to go through feast-or-famine years," he explains. "As such, we advise them to make maximum contributions to their retirement plans during feast years and then do a Roth conversion in famine years."
Like Bell, Brian Schmehil, managing director of wealth management at The Mather Group, says Roth conversions are optimal for people who suddenly find themselves in a lower tax bracket.
"A Roth conversion may be wise if you’re transitioning from filing jointly to single due to a divorce or widowhood," he says.
Doug Carey, CFA and president of WealthTrace, agrees and says the key is to focus on what your taxes look like now vs later.
"I have found that people who retire in their early to mid-50s, do not have a pension, and have very little taxable income from investments are prime candidates for a Roth conversion," he says.
Timing a Roth IRA conversion
Because Roth IRA conversions are taxable events, timing is crucial. Natasha Howe, wealth manager and vice president at Siebert Financial, says the best time to do a Roth conversion is toward the end of any year in which you've received the least amount of taxable income.
"The reason why you should wait to do it toward the end of the year is because at that point you will have a better sense of your total projected income, which ultimately determines which tax bracket you fall into for that specific year," she explains.
Carey also says that generally speaking, the sooner you can start converting, the better, provided you have a lower income tax rate than you expect to have in the future.
"By starting earlier, you allow the benefits of the Roth IRA tax treatment to compound over time," he explains. To this point, Carey notes that the longer your life expectancy, the more valuable a Roth conversion becomes.
He explains that there’s a break-even period before the conversion becomes beneficial because of the immediate tax bill it triggers. "You need time for the tax benefits to offset the upfront costs," he says.
Carey also thinks it’s wise to spread Roth conversions over time to avoid jumping into a higher federal income tax bracket.
Schmehil also warns that you must consider how your Roth conversion could impact your Medicare costs. Higher earners are subject to income-related monthly adjustment amounts, or IRMAAs, which drive up Part B and D premiums based on your modified adjusted gross income from two years earlier.
"If you're under 63 and planning to enroll in Medicare at 65, Roth conversions might be beneficial since you won’t yet face IRMAA surcharges," he explains. Otherwise, be cautious: a Roth conversion could increase your Medicare costs, at least initially.
You can use a down market to your advantage
Pay close attention to the stock market when a Roth conversion is on the table.
"Consider making a conversion when the market is down," Bell says.
The logic? During a downturn, the shares you own in your account are worth less, which means you can effectively convert more shares for the same tax bill.
"The strategy is to convert and pay taxes when the balance is relatively low and then let it grow back tax-free," Bell explains.
However, Nathan Donohue, CFP at Valence Wealth, says you need to be cautious.
"You still need to be careful of your tax brackets," he says. "Just because the market is down doesn't mean this makes long-term sense. For clients whose income lands them in the 35% to 37% bracket before state taxes, converting a large chunk of their IRA can send them a painful tax bill."
You don't have to convert all of your traditional account at once; you can tailor your conversions to remain in a lower tax bracket.
The OBBB complicates things a bit
The passage of the One Big Beautiful Bill Act (OBBB) introduced changes that could complicate Roth conversions, warns Schmehil.
"Instead of merely converting up to a certain income tax bracket or being mindful of IRMAA income levels, you now need to be aware of losing the additional $6,000 deduction for seniors over 65, with phaseouts beginning at $75,000 for singles and $150,000 for married couples," he explains.
Schmehil also warns those considering a Roth conversion to keep the new SALT (state and local tax) cap rules in mind.
"There is an increased SALT cap of $40,400 for both single and joint filers, but it begins to phase out at $505,000 MAGI," he explains. "Staying below these income thresholds may make sense in certain circumstances, even if it means converting less in a given tax bracket."
If the OBBB makes a Roth conversion less appealing, Schmehil says there are ways to soften the potential tax blow from RMDs in a traditional IRA.
"As long as you plan to make qualified charitable distributions to offset most, if not all, of your RMDs, there’s no need to do Roth conversions just to pay taxes to the government, which could have been avoided altogether if the money was directed to charity," he insists.
All told, says Schmehil, a Roth conversion needs a compelling upside to pay off.
"Conversions only make sense if you’re achieving some form of tax arbitrage, meaning paying less now to avoid higher taxes in the future," he concludes. "Estate taxes and Medicare premium increases are also part of this consideration."
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