Roth IRA Conversion: Your smart and simple guide

Aman Saxena

You may have heard that Individual Retirement Accounts, or IRAs, can be converted. But what exactly does that mean? Let’s delve into what IRA conversions entail and what they can mean for your retirement planning.

There is no better advice on taxes or retirement planning than that from a professional and qualified planner. Each person’s current financial scenario, retirement goals and risk tolerances differ.

So while this article can help you learn more about IRA conversions, it is best to consult a professional before taking any steps in your retirement planning.

📝Table of contents

What is a Roth IRA Conversion?

Let’s start at the beginning. Individual Retirement Accounts were established to help support and incentivize Americans to save for retirement. Within IRAs, there are multiple types of accounts that you can have. But each is distinctly different.

  • Traditional IRA
  • Roth IRA

There are SEP and SIMPLE IRAs which are employer-driven IRAs, including retirement accounts for those who are self-employed. Then there are the well known traditional IRA and the Roth IRA, which an individual or married couple can open.

A Traditional IRA takes pre-tax money that you have earned from work and is deposited in an IRA account where it can grow until retirement, or 70½. After age 70½, you will be required to take Required Minimum Distributions, or RMDs, from the account. And that income taken will be taxed at your tax rate at that time.

ℹ️ Traditional IRAs typically assume that you will have a lower tax rate in retirement than you do right now.

A Roth IRA is an account that you can contribute to with after-tax income. And similar to a traditional IRA the account can grow as you head towards retirement.

But when you take income from the account, it can be taken tax-free. And you can take the income whenever you choose and you do not have to take RMDs.

So, to get to it, a Roth IRA Conversion is when you convert your existing traditional IRA, SEP or SIMPLE IRA, or even employer sponsored 401(k), into a Roth IRA to enjoy the additional flexibility and tax-free withdrawals.

In certain instances, a Roth IRA can also be converted the other way to a traditional IRA.

🎯 Quick Take: Roth IRA Conversions
  • It is when you convert an IRA to a Roth IRA
  • Roth IRAs let you withdraw money tax-free in retirement
  • Can make sense if you think taxes will be going up
  • Creates a taxable event now
  • RMDs are not required for Roth IRAs

Why would you convert a traditional IRA to a Roth IRA?

Most people convert a traditional IRA to a Roth IRA to save money on taxes in the future.

As mentioned, Roth IRAs let you withdraw income from your account tax-free in retirement. On top of that, Roth IRAs don’t require you to take Required Minimum Distributions at any age.

Meanwhile, a traditional IRA has a built in assumption that your tax rate in the future will be less. So with a traditional IRA you have to pay taxes on income taken starting at age 70 ½, but the expectation is that your tax rate is lower.

So in the case of a Roth IRA conversion, if you foresee that you may have an equal or higher tax rate in retirement versus now, getting income tax-free through a Roth IRA can be an attractive option. This is especially true if you plan to move when you retire and the new residence is in a state with higher taxes.

📚 A Few Reasons to Convert a Roth IRA
  • You expect higher tax rates in retirement
  • You want to open a backdoor Roth IRA
  • You do not want to take RMDs at 70½
  • Another reason to convert an IRA to a Roth IRA is if you want to open a Roth IRA but do not fall within the income threshold required. If you earn above the maximum income cap that Roth IRAs allow, you can do a Backdoor Roth IRA by first opening a traditional IRA and then converting it to a Roth.

    The flexibility of not having to take RMDs is also a reason to convert an IRA into a Roth IRA. With a Roth IRA, you can continue to contribute to the account even when you’re in your 70s and take income when and as you wish.

    And not having to take RMDs also means you can leave more in the account to pass on to your beneficiaries or heirs, if you want to.

    While this can sound like good sense to convert an IRA to a Roth IRA, it does come with it’s own complications to be aware of.

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    How does a Roth IRA Conversion work?

    You can carry out a Roth IRA conversion by converting your IRA into a Roth IRA. But by doing so, it causes a taxable event.

    Since an IRA or 401(k) is funded by pre-tax dollars, taxes have not been paid on the amount sitting in the existing account. And a Roth IRA can only be funded with post-tax dollars.

    So to convert an IRA to a Roth IRA will require you to pay taxes on the funds in the existing IRA.

    🚀 A Roth IRA Conversion can also be called an IRA or 401 (k) rollover. Both terms are used.

    Depending on your tax status, the amount in taxes you have to pay on the funds for a conversion can feel hefty. These funds from the converting IRA are also seen by the government as income for the year that you have taken.

    This can be something to be aware of for situations like when you are applying for financial aid for college going students. Financial aid could possibly be reduced because of the additional income that appears for that year.

    There is also a likelihood that if you are a married couple making above $250,000 a year, and you are looking to convert your IRA, you may have to pay an additional 3.8% in Medicare surtax.

    Since once you have paid the taxes for converting an IRA and you have opened the Roth IRA, you will not have to pay any further taxes on the funds. Even in retirement.

    These are just a few points to weigh when deciding whether to convert an IRA to a Roth IRA or not.

    If you do look to move ahead, you will have to begin the IRA conversion process with the financial institution, firm or bank that you have your current IRA with. You can also look at rolling it to a new institution, if you desire. Check with your tax advisor and current firm to see what options exist for you to convert your existing IRA.

    How do you qualify for a Roth IRA Conversion?

    Unlike a normal Roth IRA, to convert an IRA to a Roth IRA does not have any prior qualifications required. So no matter how much you have in your IRA or your earned income is, you can convert your IRA to a Roth IRA.

    This is the go-around that conversion to a Roth IRA provides. For those that make more than the Roth IRA allows, opening a new IRA and then rolling over the funds into a Roth IRA is a possible option to go. This method is termed a Backdoor Roth IRA.

    One thing to keep in mind is that if you do convert your IRA, the funds are considered “converted funds” for the first 5 years of the Roth IRA. That means that if you want to take a lump sum out of the Roth IRA or a distribution and it is less than 5 years old, or you are under the age of 59½, it will be hit with a withdrawal penalty.

    When is the right time to convert an IRA?

    There is no right or wrong time to convert an IRA into a Roth IRA. And the decision is highly personal to your current financial situation now and slated for the future in retirement.

    Take the opportunity to speak to a retirement planner at the current bank or firm that holds your pre-tax retirement savings. Professional tax advisors can recommend whether taking on the taxable event that comes with converting an IRA makes sense for you.

    Depending on where your Roth IRA is held, you can put the newly converted funds towards investment vehicles such as fixed deposits, mutual funds, exchange traded funds or stocks.


    This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from Wise Payments Limited or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date.

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