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A Roth IRA can be a great place to stash retirement savings. Unlike a traditional IRA, there is no income tax to pay on money you withdraw or rules forcing you to empty a minimum amount annually from your account when you reach a certain age.

Even better, these retirement accounts are pretty much available to everyone. While you can’t contribute to a Roth IRA if your income exceeds the limits set by the IRS, you can convert a traditional IRA into a Roth—a process that’s sometimes referred to as a “backdoor Roth IRA.”

Key Takeaways

  • You can convert all or part of the money in a traditional IRA into a Roth IRA.
  • Even if your income exceeds the limits for making contributions to a Roth IRA, you can still do a Roth conversion, sometimes called a “backdoor Roth IRA.”
  • You will owe taxes on the money you convert, but you’ll be able to take tax-free withdrawals from the Roth IRA in the future.

How to Convert a Traditional IRA to a Roth IRA

Converting all or part of a traditional IRA to a Roth IRA is a fairly straightforward process. The IRS describes three ways to go about it:

  1. A rollover, in which you take a distribution from your traditional IRA in the form of a check and deposit that money in a Roth account within 60 days.
  2. A trustee-to-trustee transfer, in which you direct the financial institution that holds your traditional IRA to transfer the money to your Roth account at another financial institution.
  3. A same-trustee transfer, in which you tell the financial institution that holds your traditional IRA to transfer the money into a Roth account at that same institution.

Of the three methods, the two types of transfers are likely to be the most foolproof. If you take a rollover and, for whatever reason, don’t deposit the money within the required 60 days, you could be subject to a 10% penalty tax on early distributions in addition to the other taxes you’ll owe as a result of the conversion. The 10% penalty tax doesn’t apply if you are over age 59½.

Whatever method you use, you will need to report the conversion to the IRS using Form 8606 when you file your income taxes for the year.

If the value of your retirement account has dropped, it is a good time to convert to a Roth IRA because the tax impact will be less onerous than when your account is worth more.

The Tax Implications

When you convert a traditional IRA to a Roth, you will owe taxes on any money in the traditional IRA that would have been taxed when you withdrew it. That includes the tax-deductible contributions you made to the account as well as the tax-deferred earnings that have built up in the account over the years. That money will be taxed as income for the year you make the conversion.

Roth Conversion Limits

At present, there are essentially no limits on the number and size of Roth conversions you can make from a traditional IRA. The only thing the IRS prohibits savers from doing is carrying out more than one rollover each year.

You may have read somewhere that Roth IRA contributions are capped at $6,000 per year, or $7,000 per year if you are 50 or older. Those rules are still in place for 2021 but do not apply to conversions from tax-deferred savings to a Roth IRA.

The IRS prohibits savers from making more than one rollover each year.

If you wish, you can roll over all your tax-deferred savings in one hit. However, this approach is generally not advisable as it could push you into a higher tax bracket and result in a hefty tax bill.

Usually, it’s wise to patiently execute the conversion over several years and, if possible, convert more in years when your income is lower. Adopting this strategy could essentially result in you paying less tax on each dollar of converted money. Stretching transfers out may also reduce the risk of your taxable earnings being too high to qualify for a government funding program.

Beware of the Five-Year Rule

Another important thing to be aware of is the so-called “five-year rule.” Roth IRA contributions can be withdrawn tax- and penalty-free at any age. Converted funds, on the other hand, must be left in your account for at least five years. Failure to abide by this rule, will trigger an unwelcome 10% early withdrawal penalty.

The five-year period commences at the beginning of the calendar year that you did the conversion. So, for example, if you converted IRA funds to a Roth IRA in Nov. 2021, your five-year clock would start ticking on Jan. 1, 2021, and you’d be able to withdraw the funds without penalty anytime after Jan. 1, 2026. Remember, this rule applies to each conversion, meaning if you do one in 2021 and another in 2022, the latter transfer will need to be held in the account a year longer to avoid paying a penalty.

Does a Roth IRA Conversion Make Sense for You?

When you convert from a traditional IRA to a Roth, there’s a trade-off. You will face a tax bill—possibly a big one—as a result of the conversion, but you’ll be able to make tax-free withdrawals from the Roth account in the future.

One advantage Roth IRAs have over traditional IRAs is you won’t have to take required minimum distributions—something to think about if you hope to leave the money to your heirs.

One reason that a conversion might make sense is if you expect to be in a higher tax bracket after you retire than you are now. That might happen, for example, if your income is unusually low during a particular year (for example, you were furloughed or lost your job during the COVID-19 pandemic) or if the government raises tax rates substantially in the future.

Another reason that a Roth conversion might make sense is that Roths, unlike traditional IRAs, are not subject to required minimum distributions (RMDs)s after you reach age 72. So, if you’re fortunate enough not to need to take money from your Roth IRA, you can just let it continue to grow and leave it to your heirs to withdraw tax-free someday.

Moreover, if you end up still earning eligible income in retirement, you can continue to contribute to a Roth IRA and gain tax-free growth on that money. Since Jan. 2020, you can also keep contributing to a traditional IRA.

How Much Tax Will I Pay If I Convert my IRA to a Roth?

Traditional IRA deposits are generally made with pretax dollars, with income tax being paid when you withdraw the money. So, for example, if you, a single person, wanted to convert $27,000 in a tax year when you earned $60,000, your total income would be $87,000, narrowly placing you in the higher 24% tax bracket and resulting in a total tax bill for the conversion in the region of $6,480.

Alternatively, if you were to reduce the amount converted to $26,000—and perhaps convert the rest the following year—you’d fall into the 22% tax bracket, prompting a tax bill of $5,720 for the conversion and hundreds of dollars being saved.

Is There a Limit to How Much You Can Convert to a Roth IRA?

You can convert as much as you like once a year from a traditional IRA to a Roth, although it’s sometimes wise to spread these transfers out for tax purposes.

What Happens When You Convert to a Roth IRA?

In a nutshell, you pay taxes on the money you convert in order to secure tax-free withdrawals as well as several other benefits, including no required minimum distributions, in the future.

What Is the Downside of Converting From an IRA to a Roth IRA?

The most obvious downsides are the hit the conversion has on your current income—your IRA withdrawal amount counts as taxable income—and that any money transferred can’t be touched for at least five years—unless you pay a penalty.

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