How To Execute a Roth IRA Conversion

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.

There’s 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?

Roth 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’ll discuss the benefits and drawbacks of Roth conversions and give you some questions to consider when deciding if it’s the right strategy for you.

Roth IRAs – Why Do People Like Them So Much?

Let’s 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.

To withdraw from a Roth IRA tax-free you need to make a “qualified distribution”. A qualified distribution meets the following requirements:

  1. It 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
  2. The payment or distribution is:

a. Made on or after the date you reach age 59½,
b. Made because you are disabled,
c. Made to a beneficiary or to your estate after your death, or
d. One that meets the requirements listed under First home (up to a $10,000 lifetime limit).

Source: (https://www.irs.gov/publications/p590b#en_US_2018_publink1000231057)

Another advantage with a Roth IRA is that there are no Required Minimum Distributions (RMDs) when you turn 70½. This is super advantageous if you don’t think you’ll be needing your retirement funds until a much later date, since your money can grow “tax-free” for longer. Sounds like a great deal, right? Yes, but there are some drawbacks.

Read More: This Sneaky Threat To Your Retirement is Often Overlooked

Why Don’t More People Contribute to a Roth IRA?

So if Roth IRAs are so great, why doesn’t everyone open and contribute to one? Here’s 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’t contribute to a Roth IRA.

A Workaround: The Roth IRA Conversion

But wait! Before you click off of this article because you don’t 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.

How to Execute a Roth Conversion

There are two main ways that people generally execute a Roth conversion:

  1. You can contribute funds to a traditional IRA and then convert the funds to a Roth IRA. This is referred to as a “Backdoor” 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).
  2. -OR-

  3. Convert all (or a portion) of an already funded traditional IRA to a Roth IRA. But important to note: you don’t have to convert the entire balance of a traditional IRA to a Roth IRA.

Before you get too excited, it’s important to note that there is one pretty big potential drawback to Roth IRA conversions: you’ll 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’ 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.

Who Should Consider a Roth Conversion?

Given 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.

For 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 — so if you’re relatively young, a Roth IRA conversion might make sense for you.

Another time it might make sense to convert your traditional IRA assets to a Roth IRA is at the start of retirement. Typically a retiree’s 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.

Similarly, if you’re 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.

Some 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.

Where Will the Tax Money Come From?

It’s also important to consider whether you have enough liquid funds to pay the income tax that’s due upon conversion without dipping into the IRA to pay the tax. If you are under 59½ years of age, you will generally have to pay a 10% penalty on any funds that aren’t directly rolled over into the Roth IRA. So that means it’s a really bad idea to plan to pay the taxes with your IRA funds.

The Bottom Line: Opening the Door to Roth IRA Benefits

Roth IRA conversions open the door to the benefits of a Roth IRA for many people who wouldn’t normally be eligible for one. But the details and tax ramifications can be complex, so it’s a good idea to consult with your financial and tax advisors before moving forward.

Did 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.

Read More: Roth vs. Traditional 401k – What’s Best For You?

Disclaimer: 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.


The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

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