Converting Your Traditional IRA to a Roth IRA: Step-by-Step Guide

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A Roth IRA conversion is when you move your traditional individual retirement account (IRA) funds to a Roth IRA account. This allows your money to grow tax-free, and you can also access your Roth IRA tax-free in retirement.

While there are many reasons to consider converting your traditional IRA to a Roth IRA, the process can be somewhat complicated if you don’t know what you’re doing. A mistake can also cost you money, so it’s important to get it right.

Here’s a breakdown of process of converting your traditional IRA to a Roth IRA, as well as a few scenarios on when to consider Roth IRA conversions.

4 Steps to Converting a Traditional IRA to a Roth IRA

Here’s a step-by-step guide for converting your traditional IRA to a Roth IRA.

1. Choose a Roth IRA provider: Most banks and brokerages offer Roth IRAs, or a financial advisor can help you set one up.
2. Contact your plan provider or broker: If you convert a workplace account, such as a 401(k), to a Roth IRA, you’ll want to contact your provider to learn the steps required for the transfer. If you’re converting from a traditional to a Roth IRA, your broker can help you through the process.
3. Complete the required paperwork for conversion: You’ll need to complete some paperwork — usually online — to state which assets are being converted to a Roth IRA.
4. Choose how to transfer funds: Moving funds from your traditional IRA to your Roth IRA may require an ACH transfer, if using cash, or an ACAT transfer if you’re moving investments. Choose which one works for the type of conversion you’re doing.

3 Ways to Transfer Funds

These are three primary ways to transfer funds:

1. Rollover

Take a distribution from your traditional IRA and contribute it to your new Roth IRA by depositing a distribution check payable to you. Make sure to deposit the distribution check within 60 days. 

2. Trustee-To-Trustee Transfer

Instruct your current institution to transfer some or all of your assets directly to your new Roth IRA’s trustee, which the current trustee can do by issuing a check payable to the new trustee. 

3. Same Trustee Transfer

If you open your new Roth IRA at the same financial institution as your existing traditional IRA, instruct the trustee to transfer all or some assets from your traditional IRA to your Roth IRA in-house.

Once your transfer is complete, you’ll want to make sure you fill out and submit IRS Form 8606 when filing your tax return. This document lets the IRS know about the conversion, and determines the taxability of your conversion.

Things To Consider Before Converting

Before performing a Roth IRA conversion, here are a few things to consider:

Roth IRA Conversions May Be Taxable

When you convert funds from a traditional IRA or workplace retirement account to a Roth IRA, it may be seen as taxable income. This could cause an unexpected tax bill which can affect both your federal and state income taxes.

You Might Need To Wait 5 Years To Access Funds

If you’re under age 59 ½, Roth IRA conversions limit access to some of your funds for five years. While you can access contributions at any time, you cannot access earnings for at least five years after the conversion.

It May Affect Government Assistance

Since Roth IRA conversions typically count as taxable income, this can affect benefits from government programs. Subsidies from ACA healthcare plans can be affected if your income rises too much, and even your children’s student aid options from FAFSA can be affected. It’s a good idea to meet with a licensed tax advisor before completing a Roth conversion.

You Might Run Out of Time

Roth IRA conversions can be a good idea in years where your income is lower, but make sure you do it by the end of the year. Roth conversions must be made by December 31 of the tax year you want it to count toward.

How To Minimize Taxes When Converting

Roth IRA conversions usually count as taxable income, so it’s important to understand the details of your tax situation before converting. Here are a few ways to minimize taxes when performing a Roth IRA conversion:

• Consider converting during a market downturn when the value of your holdings might be lower.
• If you’re planning to move from a high-tax state to one with lower taxes, postponing until after the relocation could lower your tax bill. 
• A period of lost income or a job gap could help reduce your obligation to the IRS.
• Conduct partial conversions over several years to spread out your tax bill. 
• Use deductions and credits to offset conversion taxes.
• Making a charitable donation could reduce your tax obligation.

Common Mistakes To Avoid

Making mistakes during a Roth IRA conversion can end up costing you money. Here’s a few common Roth IRA conversion mistakes to watch out for:

• Underestimating the tax bill: Always calculate the upfront IRS obligation before you execute the conversion.
• Converting too much at once: Moving large amounts could push you into a higher tax bracket. 
• Not considering future retirement needs: Make sure to account for the long-term benefits of tax-free withdrawals.
• Not working with a financial advisor: Trying to do a Roth IRA conversion on your own could lead to mistakes that could lead to IRS penalties or high tax bills. Consider working with a licensed financial advisor to help guide you through the process.

Is a Roth IRA Conversion Right for You?

A Roth IRA conversion isn’t the right move for everyone. But if you’re looking to take control of your taxes and optimize your retirement, here are a few reasons to consider a Roth IRA conversion:

You Take a Gap Year

If you’re taking a year off work, or maybe you just sold a business and aren’t working this year, you might consider a Roth IRA conversion. With little to no taxable income, you can convert some funds into a Roth IRA and pay much lower taxes.

You Earn Too Much Money

If your income is too high, you can’t contribute directly to a Roth IRA.

For example, these are the limits

• MAGI of $150,000 if single
• $236,000 if married filing jointly

If this applies to you, you can do a Roth IRA conversion instead.

Known as a “Backdoor” Roth IRA, you contribute to a traditional IRA then convert to a Roth IRA — avoiding the income limits of a direct conversion.

You Expect Higher Tax Rates in Retirement

If you expect higher income taxes in retirement, it may be worth converting your traditional 401(k) or IRA to a Roth IRA. Paying taxes on the conversion now may be less than a higher taxable income later.

You Want To Leave a Tax-Free Inheritance

Roth IRAs have less limitations than traditional IRAs when passed on to non-spouse heirs.

Traditional IRAs must be spent within 10 years of inheriting by a non-spouse, and withdrawals are taxable.

Roth IRAs must also be spent within 10 years, but withdrawals are tax-free.

Take Control of Your Retirement With a Roth IRA Conversion 

Roth IRA conversions can help you lower your taxable income in retirement and allow your investments to grow tax-free. You might end up with a large unexpected tax bill if you do a conversion without proper tax planning.

It might be a good idea to work with a licensed tax pro or financial advisor before performing a Roth conversion so you can get the best results.

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