Should You Convert a Traditional IRA to a Roth IRA?

IRAs are great funding vehicles for your retirement. Traditional IRAs, which grow tax-deferred, allow your retirement funds to grow more quickly. On the other hand, if you’d like to avoid paying taxes during your retirement, Roth IRAs may be the best option.

The IRS places restrictions on IRAs. Contributions must be earned income and there is a limit on how much you can contribute annually. However, there are currently no restrictions to converting a traditional IRA into a Roth IRA, also known as a backdoor Roth IRA conversion. Here’s what you need to know if you’re considering converting a traditional IRA to a Roth IRA.

Pros: The Benefits of Converting Your Traditional IRA to a Roth IRA

Converting a traditional IRA to a Roth IRA is a good idea if you have significant assets in a traditional IRA and you think that your tax liability will be higher when you plan to withdraw the money.

Roth IRAs do not require you to take required minimum distributions (RMDs) each year. Other types or retirement accounts require RMDs starting when you reach age 73. This makes Roth IRAs especially attractive if you want to leave those assets to your heirs or just let your money grow for longer.

Cons: The Downsides of Converting Your Traditional IRA to a Roth IRA

There is a five-year holding period on accessing money that was part of a Roth conversion. Plus,

you will have to pay the tax bill on all the converted funds. If possible, you should not use any of the money from your IRA to do this. If you are younger than 59 ½ and keep out some of your withdrawal to pay these taxes, you could face a 10% penalty. While paying taxes on a conversion may save you money if your account grows, what you pay in taxes is money that could have helped accelerate your account growth.

All or some of the money you convert can be considered income by the IRS, so if you are near the upper limit of your current tax bracket you should think carefully about when to convert — or plan to convert just a portion of your traditional IRA into a Roth IRA each year. It will also be reported as income on the FAFSA if you have children attending college, which could impact their access to financial aid.

FAQ: Roth IRA Conversion

How Do I Convert a Traditional IRA to a Roth IRA?

With a rollover, you can take a distribution check from your traditional IRA and deposit that money into a Roth account. You must deposit it within 60 days or you could be hit with a penalty tax. With a trustee-to-trustee transfer, the financial institution that holds your traditional IRA transfers your assets to your Roth IRA account at a different institution. And with a same-trustee transfer, the financial institution that holds your traditional IRA transfers your assets to a Roth account within the same institution. 

How Much Can I Convert from a Traditional IRA to a Roth IRA?

You can convert any amount to a Roth IRA, but keep in mind that you will have to pay taxes on that money. You should have enough non-retirement earmarked funds to pay those taxes. If you can’t cover the taxes for all the money in your traditional IRA, consider spreading your conversion over a few years. You should also consider your tax bracket when converting and talk to your advisor about whether a conversion will move you to a higher tax bracket.

When Can I Convert a Traditional IRA to a Roth IRA?

You can convert a traditional IRA to a Roth IRA at any time. However, you may want to talk with your financial advisor and determine the best timing. Perhaps you changed jobs, were unemployed for a time or didn’t qualify for a bonus. If any of those circumstances dropped you into a lower tax bracket, it would be a good year to convert your IRA. Or if the market hasn’t performed well and your balance is low, it may be the perfect time to convert those funds because you’ll pay less in taxes. Also, the earlier in the year you convert, the better. You have until April of the following year to pay taxes, so converting early in the year gives you more time to spread out payments on your tax liability. 

Can I Do a Roth Conversion If I’m Retired?

Being retired does not preclude you from converting a traditional IRA to a Roth IRA. However, you can’t access the money for five years, so make sure you don’t need the money in the near future if you plan to convert to a Roth IRA.

We Can Help

If you have questions about the best way to plan for retirement, whether that includes an IRA conversion or not, talk with a financial advisor about your options.