Converting a Traditional IRA to Roth IRA

By | March 9, 2014

It’s generally a good idea for most investors to consider including a Roth IRA in their overall retirement planning. Roth IRAs have the potential to grow tax-free, which may help you save more over time. One of the primary benefits of using a Roth IRA is that you don’t pay income tax when you withdraw funds in retirement. Unfortunately not everyone meets IRS standards to contribute to a Roth IRA.

Why should you Look at Converting a Traditional IRA to Roth IRA?

The primary reason individuals are not allowed to contribute is because their incomes exceed the Roth IRA income limits. Generally, converting to a Roth IRA means undoing the tax deferral by paying tax on the accumulated earnings and on any savings contributions for which the person took a deduction. This converts the funds into post-tax money.


Who Eligible to Convert Traditional IRA to Roth IRA?

Anyone can convert their eligible IRA assets to a Roth IRA regardless of income or marital status. You can convert all or part of other retirement accounts, such as an employer-sponsored 401k or 403b plan, too, once you leave your job, or in some cases, even while you continue to work for the same employer. Some plans allow you to access the money while you are still working, known as an “in-service distribution”, but you usually have to reach age 59 ½ before you can do so.


Rules on Conversion to Roth IRA

Generally, converted assets in the Roth IRA must remain there for at least five years to avoid penalties and taxes. Distributions from a Roth IRA are tax-free and penalty-free provided that the five-year aging requirement has been satisfied and at least one of the following conditions has been met:

  • You reach age 59½
  • You pass away
  • You become disabled
  • You make a qualified first-time home purchase


Tax Compliance for Roth Conversion (Form 1099-R)

In order to report a Roth IRA conversion, the taxpayer will be issued Form 1099-R showing the total distribution made from their Traditional IRA account by the company that is running the IRS.  The full distribution does not need to be converted to a Roth IRA, however, any amounts not converted are subject to additional taxes and penalties. Taxpayers may wish to gradually convert an IRA to enjoy several tax advantages.  Conversions must be reported on Form 8606, Part II.  Form 1099-R must be entered into the tax program before computing the taxable amount on Form 8606.


When does a Roth Conversion Occur?

A Roth Conversion will be considered to occur in the tax year and must occur by Dec. 31 to be counted for the current tax year.


Rolling a 401(k) directly into a Roth IRA

If you qualify, you can do an eligible rollover distribution from your old 401(k) directly to a Roth IRA. You’ll owe taxes on the amount of pretax assets you roll over. Note also, if you have assets in a Designated Roth Account (i.e., Roth 401(k)) and would like to roll these to an IRA, the assets must be rolled into a Roth IRA. As with Traditional IRA conversions to Roth IRAs, if you are required to take an MRD in the year you roll over into an IRA, you must take it before rolling over your assets.