Roth Conversion FAQs

by Craig Moser on January 11, 2019

If a savings vehicle with tax-free growth potential and tax-free withdrawals in retirement sounds good to you, you should probably consider a Roth IRA.  Even if you can’t contribute to a Roth IRA (because of income limits), you might still be able to take advantage of the Roth’s benefits through a Roth conversion.  Here are some common questions, and answers, about Roth conversions to help improve your understanding.

Roth Conversion Basics

Does the time of year make a difference?

There are different advantages to converting at different times of the year.  Whether it’s better to convert early or late in the year depends on your individual circumstances.

You pay taxes on money converted from your traditional IRA into a Roth.  (The 10% penalty for early withdrawals from your traditional IRA is waived). Taxes on the conversion aren’t due until April 15th of the following year.  This means converting earlier in the year may give you more than 15 months to pay the taxes.

If you think you may withdraw converted funds within 5 years, converting later in the year may potentially let you access the money almost a full year sooner.  You see, there’s a 5-year rule where you pay a 10% penalty on withdrawals from converted funds made within 5 years.  The clock starts in January of the year you make a Roth conversion.  In other words, if you convert on December 31, it’s the same as converting on January 1 in regard to the 5-year rule.

Another bonus of converting later in the year is that you have a better idea on income taxes for that year.  This scenario may enable you to convert a specific amount without bumping you into a higher tax bracket.  The amount converted from your traditional IRA is considered taxable income.  Depending on your individual situation, this could push you into a higher tax bracket.

I make too much to contribute to a Roth IRA.  Can I still convert my Traditional IRA to a Roth?

Yes.  Just remember you can convert any amount you want, and the amount you convert is considered taxable income.  You may want to convert no more than what you will think brings you to the top of your current tax bracket without going over.  Another consideration is basing your conversion amount on the tax liability you incur.  This lets you pay taxes from a nonretirement account.

Can I convert my traditional 401k to a Roth IRA?

Provided you’re eligible to make 401k withdrawals at the time of conversion, the short answer is yes.  There are different ways of doing this depending on whether your contributions were pre-tax or after-tax, and if your 401k plan tracks contribution sources separately.  These factors determine how the conversion is made and whether tax liability results.

Roth Conversion and Taxes

How do I estimate taxes on an IRA Conversion?

Taxable income generated by the conversion and your tax rate determine your tax liability.  You also need to know the types of contributions in your non-Roth IRAs.  Contributions to a non-Roth IRA may be deductible, post-tax, or some combination.

If you’ve never made nondeductible contributions to any non-Roth accounts, estimating taxes is straightforward.  In this scenario, the full amount you convert is taxable income.

If you have nondeductible contributions in any of your non-Roth accounts, it can get a little tricky.  The IRS doesn’t let you cherry-pick and only convert nondeductible contributions.  You need to determine the percentage of nondeductible contributions across all of your non-Traditional Roth IRA accounts (excluding inherited IRAs).  Use the percentage to determine how much of the conversion isn’t taxable.  To get the percentage, you will total both balances and nondeductible amounts in all your non-Roth IRAs.  (Remember not to include inherited IRAs and/or your spouses IRA.  Think of all your non-Roth IRAs as one account).  This hypothetical example shows how to figure the portion of your IRA conversion that is taxable.

Roth Conversion and Taxes


Roth Conversion and RMDs

I’m over 70 ½.  Do I still need to take a required minimum distribution (RMD) in the year I covert?

Yes.  Generally speaking, the first money you withdraw from your account each year is your RMD.  That money isn’t eligible for conversion.  Amounts you withdraw over your RMD amount can be converted to a Roth, and they don’t require RMDs.  Because converting the RMD amount itself may result in taxes and an excess Roth contribution, remember to satisfy your RMD first.  (Money you withdraw to satisfy your RMD, after paying taxes on the RMD, can be used to pay taxes on the conversion).

Once you reach age 70 ½ you’re required to take an RMD each year from your pre-tax retirement accounts.  That includes traditional, SEP, rollover and Simple IRAs, in addition to employer retirement accounts.  Keep in mind Roth IRA’s are exempt from RMDs, but Roth 401ks aren’t.  Also, there are different RMD rules for inherited retirement accounts.  If you have questions specific to your accounts, just let me know.

How does North Carolina tax Roth conversions?

In North Carolina, converting your traditional IRA or rollover to a Roth IRA results in a taxable event.  Just like the federal government, our state government views the conversion as income and it’s taxed accordingly.

Should I convert?

Because Roth IRA’s offer tax-free growth potential and tax-free withdrawals, there are obvious benefits.  However, there are other factors to consider, and the answer depends on your individual situation and goals.  If you have specific questions about converting your accounts, just let me know.  I’m always happy to help.

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