How to Convert a Traditional IRA to a Roth IRA

Learn who should convert and how to use a "backdoor" Roth IRA.

Making the most of your retirement savings means using products like traditional and Roth individual retirement accounts in the best way for your particular situation. It’s important to understand when to use a traditional IRA and when to use a Roth IRA and what the tax benefits are of each. Here’s what you need to know about these important types of retirement accounts and how they can help you meet your financial goals.

The Difference Between a Traditional IRA and a Roth IRA

Whereas these two types of accounts differ in several ways, the two major ones concern taxes and withdrawals. A traditional IRA is an account into which you deposit pre-tax money, meaning you don’t pay income tax on the amount you invest. You pay the taxes when you withdraw money during retirement. And you must withdraw a certain amount each year beginning the year you turn 70 1/2 years old.

With a Roth IRA, you deposit money you have already paid taxes on — after-tax money. But you don’t have to pay taxes on the money when you withdraw it in retirement as long as you’ve had it in the account for at least five years. And you don’t have to take it out if you don’t want to.

Related: Roth vs. Traditional IRA — Which Retirement Plan Is Best for Me? 

Retirement Planning and IRAs

When the IRA first became available, people assumed it would be advantageous to put off paying taxes until they reached retirement age. They reasoned that they would likely have less income in retirement, so they would be in a lower tax bracket than during their working years. This is often, but not always, true. Some people have as much income in retirement as they had when they were working. And tax brackets change periodically. Plus, some people don’t like the idea of having to pay income taxes when they’re retired. Roth IRA rules make the accounts an attractive option for these folks.

A ‘Backdoor’ Roth IRA

IRA rules limit how much income you can make and still contribute to a Roth IRA. In 2018, a married couple filing jointly must have a modified adjusted gross income of less than $189,000 to contribute the full allowable amount of $5,500 each — $6,500 for those over 50 years old. Couples with a modified AGI between $189,000 and $199,000 can contribute a reduced amount. Single taxpayers’ modified AGI must be less than $120,000 for a full contribution, and from $120,000 to $134,999 for a reduced contribution amount.

A technique known as the “backdoor” Roth paves the way for higher earners to contribute to a Roth IRA. By contributing to a traditional IRA and then immediately converting it, these individuals can save for retirement in a Roth IRA.

See Also: 17 IRA Withdrawal Rules You Need to Know

Converting a Traditional IRA to a Roth IRA

You could have a traditional IRA that you’ve been contributing to for some time but think a Roth IRA might be a better choice. In this case, you can convert some or all of the money in your traditional IRA to a Roth IRA. There’s one caveat: you must pay taxes on the money you convert.

1. Here’s how to convert a traditional IRA to a Roth IRA:

  • Open a Roth IRA account at a bank or online brokerage or with a financial advisor.
  • Complete a form indicating how much money you want to convert from your existing IRA account to a Roth IRA account.

Discover: Roth IRA Investment Options 

2. Keep these rules in mind when converting your IRA:

  • You must pay taxes on the amount you convert. You can ask your traditional IRA custodian to withhold the taxes, or you can pay when you file your income tax return.
  • If you are taking required minimum distributions from your IRA because you’re older than 70 1/2, you will have to take your RMD for the current year before you convert.
  • Your converted funds must be in your Roth IRA for five years before you can withdraw them tax-free.

Reversing a Conversion

You can reverse the process if you convert your traditional IRA to a Roth IRA and then change your mind. That said, you’ll have to hurry — 2017 is the last tax year for which you can re-characterize a Roth conversion, and the deadline is October 2018. The process must be completed by the time your 2017 income tax return is due, including extensions.

Before recharacterizing a Roth conversion back to a traditional IRA, consult a financial advisor or tax advisor to make sure it’s the right decision.

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