Roth Conversion Tax Rules: What You Need to Know

Sep 12, 2018 |

How to avoid costly tax mistakes with an IRA to Roth conversion

A traditional IRA to Roth conversion can be a savvy financial move, but it’s not without potential tax implications. Failing to recognize the burden taxes could impose on your retirement savings could be a mistake.

As companies continue to shave pension benefits or eliminate them altogether, many people are taking a closer look at their personal retirement savings strategies to help fill the gap.

Part of this review considers the switch from a traditional IRA to a Roth. The traditional IRA has long been a popular component of retirement planning, but the tax advantages of the Roth IRA are hard to ignore.

If you’re considering converting from a traditional IRA to a Roth IRA, it’s important you understand the Roth conversion tax rules before you make the switch.

Traditional IRA vs. Roth IRA: What’s the Difference?

Traditional and Roth IRAs are the two main types of individual retirement accounts. Both are accounts specifically for retirement savings. You can contribute up to $6,000 per year ($7,000 for those aged 50 years and older). The main difference lies in the fact that you contribute pre-tax money to the traditional IRA, whereas your funds for a Roth IRA have already been taxed.

Keep in mind that you will still be required to pay taxes on the money you contribute to the traditional IRA, but this expense is deferred until retirement. You will then pay taxes on the money as you withdraw it.

Comparing the Benefits of Traditional and Roth IRAs

Traditional IRAs can have an advantage over Roth IRAs when it comes to taxes. If you have a deductible IRA (as opposed to the non-deductible option), you can deduct some or all of your contributions from your annual tax return. Many people choose the traditional IRA for this reason.

The money in your Roth IRA can sit in the account for as long as you like.

However, Roth IRAs are typically seen as being more flexible than traditional IRAs in several aspects. For starters, you can contribute money to your Roth IRA at any age. Once you turn 59½, you can withdraw money from your Roth IRA at any time, even for non-retirement-related activities. (Before that age threshold, you will incur a 10 percent penalty if you withdraw investment earnings unless it’s a qualified distribution.) In addition, the money in your Roth IRA can sit in the account for as long as you like.

There is one other notable caveat to Roth IRA withdrawals: a five-year rule means that withdrawals will be classified as a qualified distribution only if it has been at least five years since you first opened and contributed to the account, regardless of your age.

For comparison, traditional IRAs require you to withdraw a certain amount each year after you turn 70 ½. And once you reach this age, you are no longer able to contribute funds to your traditional IRA without paying the tax on excess IRA contributions.

Income Limitations

Traditional and Roth IRAs each have income-related restrictions. For traditional IRAs, you must be 70 ½ years or younger to contribute money without paying an additional tax. Your total income will determine if your contribution is tax deductible. Your tax deduction will also depend on whether you or your spouse has a retirement plan through work, like a 401(k).

Roth IRAs don’t impose any age restrictions. However, you must have an adjusted gross income of less than $135,000 ($199,000 for married couples filing jointly).

IRA to Roth Conversion: Is It Right for Me?

There is no right answer when considering sticking with a traditional IRA or switching to a Roth IRA. However, understand that a traditional IRA to Roth conversion is a taxable event. It may take a while before you recoup this expense and start benefiting from your decision to switch.

Roth Conversion Tax Rules

You can choose to convert some or all of your traditional IRA funds to a Roth IRA. You will only be taxed on the amount you convert, which is taxed at the same rate as your regular income.

In other words, the amount you’re transferring to a Roth IRA will count as additional income, which could push you into the next tax bracket.

While your contributions to a Roth IRA are taxed, the earnings you gain from them are not.

How much of your Roth IRA contribution will be subjected to tax depends on if that amount was deductible. If so, your contributions and their gains will be taxed at the full amount. If you had nondeductible traditional IRA contributions, this amount would not be subject to tax.

Also, remember that while your contributions to a Roth IRA are taxed, the earnings you gain from them are not. When you withdraw earnings, you will not be expected to pay taxes on that amount.

Tax Impact of a Traditional to Roth IRA Conversion

There are a couple of ways you can go about paying the tax on your traditional to Roth IRA conversion.

The most common is to include it with your regular income tax payment to the IRS. This is because the additional “income” that stems from the conversion will usually offset any deductions or losses on your tax return.

Some people make the mistake of using the IRA funds that are being converted to pay the tax, but doing so means you will have less to contribute to your Roth IRA account. This ultimately limits the tax-free growth of your gains. You will also have to pay the 10 percent penalty on the money you don’t convert to the Roth IRA if you are under the age of 59 ½.

One Final Consideration

Tax implications aren’t the only downside you need to consider.

When you convert to a Roth IRA, you are allowed to withdraw tax-free the amount you converted without paying a penalty within the first five years, but you are subject to the five-year rule on earnings.

This is a major factor to consider if you are less than five years away from retiring. It’s important that if you do convert to a Roth IRA, you do so in plenty of time for your retirement.

When Does a Traditional IRA to Roth Conversion Make Financial Sense?

Despite having to pay taxes on pre-taxed funds to convert to a Roth IRA, several scenarios may warrant the conversion. Do any of these apply to you?

  • You anticipate being in a higher income tax bracket when you retire than you are currently in.
  • You don’t plan to take any distributions when you turn 70 ½.
  • You are relocating to a state with higher income taxes.
  • Your other losses or deductions will offset the amount you’d pay for your conversion.
  • The total value of your IRA investment might be hitting a low point.

These are the most common circumstances when people decide to switch to a Roth IRA, but it is not meant to be an exhaustive list.

Another scenario when conversion might be useful is if you’re starting to save for retirement at an early age. Are you nervous or unsure about stashing away money for so long and not being able to get to it? A Roth IRA gives you peace of mind, knowing that you can access your funds in the event of financial need.


There are plenty of positives to both traditional and Roth IRAs. Having a diversified portfolio of assets can help you maximize your gains, especially if the future is unclear.

Our advisors can work with you to determine the long-term financial impact of converting to a Roth IRA to see if it makes the most sense for your situation. Contact our team today to see how you can maximize your retirement savings for the future you envision.

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