A Roth IRA conversion or a Backdoor Roth IRA conversion offers those who aren't able to contribute to a Roth IRA due to income restrictions a workaround.\r\nThere\u2019s no doubt about it, Roth IRAs are a great option when it comes to retirement savings. But there are some restrictions that prevent a lot of people from contributing to one, which raises the question, am I a good candidate for a Roth conversion or a backdoor Roth conversion?\r\n\r\nRoth conversions can definitely make sense for some people, but there are several things to consider if you are thinking about executing one. In this article, we\u2019ll discuss the benefits and drawbacks of Roth conversions and give you some questions to consider when deciding if it\u2019s the right strategy for you.\r\nRoth IRAs - Why Do People Like Them So Much?\r\nLet\u2019s start with a little refresher on Roth IRAs. Contributions are made with after-tax dollars and allow your retirement savings grow tax-free. A big advantage of a Roth IRA is that unlike a traditional IRA, you may be able to withdraw from the account tax-free.\r\n\r\nTo withdraw from a Roth IRA tax-free you need to make a \u201cqualified distribution\u201d. A qualified distribution meets the following requirements:\r\n\r\n \tIt is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and\r\n \tThe payment or distribution is:\r\n\r\na. Made on or after the date you reach age 59\u00bd,\r\nb. Made because you are disabled,\r\nc. Made to a beneficiary or to your estate after your death, or\r\nd. One that meets the requirements listed under First home (up to a $10,000 lifetime limit).\r\nSource: (https:\/\/www.irs.gov\/publications\/p590b#en_US_2018_publink1000231057)\r\nAnother advantage with a Roth IRA is that there are no Required Minimum Distributions (RMDs) when you turn 70\u00bd. This is super advantageous if you don\u2019t think you\u2019ll be needing your retirement funds until a much later date, since your money can grow \u201ctax-free\u201d for longer. Sounds like a great deal, right? Yes, but there are some drawbacks.\r\n\r\nRead More: This Sneaky Threat To Your Retirement is Often Overlooked\r\nWhy Don't More People Contribute to a Roth IRA?\r\nSo if Roth IRAs are so great, why doesn\u2019t everyone open and contribute to one? Here\u2019s the catch: there are income limitations that prevent a lot of people from contributing to them. Anyone with modified adjusted gross income (MAGI) above $137,000 (for singles) or $203,000 (for married couples filing jointly) in 2019 can\u2019t contribute to a Roth IRA.\r\nA Workaround: The Roth IRA Conversion\r\nBut wait! Before you click off of this article because you don\u2019t meet those income restrictions -- there is a workaround that could allow you to benefit from a Roth IRA. This strategy is known as a Roth IRA conversion, and that basically means converting traditional IRA dollars into Roth IRA dollars.\r\nHow to Execute a Roth Conversion\r\nThere are two main ways that people generally execute a Roth conversion:\r\n\r\nYou can contribute funds to a traditional IRA and then convert the funds to a Roth IRA. This is referred to as a \u201cBackdoor\u201d Roth Conversion. When implementing this strategy you do not take a deduction on the traditional IRA contribution, and you want to be careful of the pro-rata rules the IRS applies. This method works best if you have no assets in an IRA (traditional, SEP or SIMPLE). -OR-\r\nConvert all (or a portion) of an already funded traditional IRA to a Roth IRA. But important to note: you don\u2019t have to convert the entire balance of a traditional IRA to a Roth IRA.\r\n\r\n\r\nBefore you get too excited, it\u2019s important to note that there is one pretty big potential drawback to Roth IRA conversions: you\u2019ll have to pay income taxes on the value of the traditional IRA assets that have not been taxed yet when you make the conversion. This could result in a big ol\u2019 tax payment at the time of the Roth IRA conversion. Also, since the converted funds will probably be considered income during the year you make the conversion, this could bump you up into a higher tax bracket during that year. So it is best to consult your financial advisor and tax professional before deciding to execute a Roth conversion.\r\nWho Should Consider a Roth Conversion?\r\nGiven the tax implications, is a Roth IRA conversion a smart financial decision? There are several factors to consider when thinking about whether this is the right move for you.\r\n\r\nFor example, Roth IRAs tend to be most beneficial for retirement savers whose tax bracket is lower now than they will likely be when they retire. This is generally true for younger people and couples \u2014 so if you\u2019re relatively young, a Roth IRA conversion might make sense for you.\r\n\r\nAnother time it might make sense to convert your traditional IRA assets to a Roth IRA is at the start of retirement. Typically a retiree\u2019s tax bracket is lower at the start of retirement versus the end of their accumulation stage (when you are working and building up your investments), especially if the retiree isn't collecting social security or subject to RMDs yet. Converting to a Roth IRA at the start of retirement can also be a great legacy planning move as an account to pass on to any heirs.\r\n\r\nSimilarly, if you\u2019re in a lower tax bracket this year than you normally are, this might be a good time for a Roth IRA conversion. For example, maybe you own a business and your income is down this year, or maybe you were between jobs for a period of time, which will lower your MAGI for the year.\r\n\r\nSome other situations that might make sense to implement a Roth conversion is if your IRA has lost value recently. For example, uncertainty about tariffs and a trade war with China prompted stocks to take a nosedive in early-to-mid May. Also, if you are facing a net operating loss (NOL), this could help offset taxable income that results from the Roth IRA conversion.\r\nWhere Will the Tax Money Come From?\r\nIt\u2019s also important to consider whether you have enough liquid funds to pay the income tax that\u2019s due upon conversion without dipping into the IRA to pay the tax. If you are under 59\u00bd years of age, you will generally have to pay a 10% penalty on any funds that aren\u2019t directly rolled over into the Roth IRA. So that means it\u2019s a really bad idea to plan to pay the taxes with your IRA funds.\r\nThe Bottom Line: Opening the Door to Roth IRA Benefits\r\nRoth IRA conversions open the door to the benefits of a Roth IRA for many people who wouldn\u2019t normally be eligible for one. But the details and tax ramifications can be complex, so it\u2019s a good idea to consult with your financial and tax advisors before moving forward.\r\n\r\nDid you know? Personal Capital's team of advisors can help you decide if a Roth conversion or a Backdoor Roth conversion is a good strategy for you. Learn more about the process of working with a Personal Capital advisor here.\r\n\r\nRead More: Roth vs. Traditional 401k - What's Best For You?\r\n\r\nDisclaimer: The information and content provided herein is general in nature and is for informational purposes only. It is not intended and should not be construed as a specific recommendation, or legal, tax or investment advice, or a legal opinion. Individuals should contact their own professional tax advisors or other professional to help answer questions about specific situations or needs prior to taking action based on this information. Tax laws and authorities are subject to change, either prospectively or retroactively, and any subsequent change could have a material impact on your situation. To comply with U.S. Treasury Regulations, in particular IRS Circular 230, we also inform you that, unless expressly stated otherwise, the information contained in this communication is not intended to and cannot be used to avoid IRS penalties, and is provided to support the marketing of our services.