How Roth conversions work with taxes

When you convert money from a traditional IRA to a Roth IRA, you owe income tax on the amount you convert in that same tax year. The IRS treats a conversion as if you withdrew the money — which means it counts as taxable income on your Form 1040. You do not pay the tax from the converted funds themselves; you pay it separately from your regular income, usually when you file your return.

The tax bill depends on how much you convert and what portion of your IRA balance consists of pre-tax versus after-tax contributions. If your entire IRA is pre-tax money (the most common situation), you owe tax on the full amount converted. If you have made after-tax contributions to a traditional IRA, the calculation becomes more complex, and you may owe tax on only part of the conversion.

This is the central trade-off of a Roth conversion: you pay tax now to move money into an account where future growth and withdrawals are tax-free. The decision hinges on whether you expect your tax rate to be higher in retirement than it is today.

Key Takeaways

  • You owe federal income tax on the full amount converted in the year you convert it, reported on your Form 1040.
  • The tax is calculated based on your total income for that year, which may push you into a higher tax bracket.
  • If your traditional IRA contains both pre-tax and after-tax money, the IRS uses a formula called the pro-rata rule to determine how much of the conversion is taxable.
  • State income tax may also explore to the conversion, depending on where you live and whether your state taxes retirement income.
  • You can reduce the tax impact by converting in a year when your income is lower, such as after retirement or a job loss.

Understanding the pro-rata rule

If you have contributed after-tax dollars to a traditional IRA at any point — money you did not deduct on your tax return — the IRS does not let you convert only the after-tax portion tax-free. Instead, it applies the pro-rata rule, which treats all your traditional IRAs as a single pool.

The formula works like this: divide your total after-tax contributions across all traditional IRAs by your total IRA balance (including SEP-IRAs and straightforward IRAs). That percentage applies to your conversion. If you have $100,000 in traditional IRAs and $10,000 of it is after-tax money, then 10 percent of any conversion is tax-free and 90 percent is taxable.

This rule catches many people off guard. You cannot sidestep it by keeping after-tax money in one account and converting from another. The IRS looks at your entire IRA picture on December 31 of the conversion year. If you want to avoid the pro-rata rule, you must have zero balance in all traditional IRAs, SEP-IRAs, and straightforward IRAs by year-end — a strategy called a "backdoor Roth" that requires careful timing.

How the conversion affects your tax bracket

The converted amount is added to your other income for the year, which can push you into a higher tax bracket and increase the tax you owe on all your income. This is called bracket creep. If you earn $75,000 and convert $50,000, the IRS treats you as having $125,000 in income for that year.

The tax impact varies by state and federal bracket. At the federal level, tax brackets for 2024 range from 10 percent to 37 percent depending on filing status and total income. A conversion that bumps you from the 22 percent bracket to the 24 percent bracket means you pay 24 percent tax on the converted amount, not 22 percent.

Some conversions also trigger the Net Investment Income Tax (NIIT), a 3.8 percent additional tax on certain investment income if your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). The conversion counts toward this threshold, so a large conversion can unexpectedly set up the NIIT.

State taxes on conversions

Most states that have an income tax treat Roth conversions the same way the federal government does: as taxable income in the year of conversion. A handful of states — including Pennsylvania, Illinois, and Mississippi — do not tax retirement income, which can make conversions cheaper if you live there.

If you live in a state with income tax and are considering a conversion, factor in your state rate on top of the federal rate. A conversion that costs you 24 percent federal tax might cost an additional 5 to 10 percent in state tax, depending on where you live. Some people who move in retirement plan conversions around their move to take advantage of lower-tax states.

Timing conversions to minimize the tax bill

You can reduce the tax cost of a conversion by doing it in a year when your income is unusually low. Common timing strategies include converting in the year you retire (before you start taking Social Security or pension payments), in a year when you take a sabbatical, or after a job loss.

If you are self-employed, a year with lower business income is an ideal conversion year. If you have significant capital losses from investments, you can use those losses to offset other income, leaving more room in your tax bracket for a conversion at a lower rate.

You can also split a large conversion across multiple years to spread the tax impact. Converting $100,000 in one year might push you into the 32 percent bracket, but converting $25,000 in each of four years might keep you in the 24 percent bracket all four years, saving you money overall.

What happens if you cannot pay the tax bill

The IRS does not require you to pay the conversion tax from the converted funds. You can pay it from a savings account, a paycheck, or any other source. However, if you use money from the Roth IRA itself to pay the tax, that withdrawal counts as a distribution and may trigger penalties.

If you convert $50,000 and take $12,000 from the Roth to pay the tax bill, you have only $38,000 left in the Roth, and the $12,000 withdrawal is subject to the early withdrawal penalty if you are under 59½ and have not met the five-year holding period. This defeats much of the purpose of the conversion.

If you cannot pay the tax from outside sources, you can undo the conversion by requesting a recharacterization from your IRA custodian. However, recharacterizations are no longer allowed under current law (as of 2018) except in narrow circumstances, so this option is rarely available. Plan to have the tax money ready before you convert.

Conversions and Medicare premiums

A Roth conversion can also increase your Medicare premiums if you are on Medicare or will be soon. Medicare uses your modified adjusted gross income (MAGI) from two years prior to set your premiums. A conversion in 2024 affects your 2026 Medicare premiums.

If your MAGI crosses certain thresholds — $97,000 for single filers and $194,000 for married couples filing jointly in 2024 — you pay higher premiums for Part B (medical insurance) and Part D (prescription drug coverage). A large conversion can bump you into a higher premium tier, costing you hundreds or thousands of dollars over two years.

This is a reason to model conversions carefully if you are within a few years of Medicare may be able to access. The tax savings from a conversion might be offset by higher Medicare premiums down the road.

Frequently Asked Questions

Do I have to pay the conversion tax when ready?

No. You owe the tax when you file your return for the year of conversion, typically by April 15 of the following year. You can pay it then, or if you owe other taxes, it rolls into your total tax bill. If you cannot pay by the important date, you can request a payment plan from the IRS, though interest and penalties will accrue.

Can I deduct the conversion tax as a loss?

No. The tax you pay on a conversion is not deductible. It is straightforward the cost of moving pre-tax money into a tax-free account. You cannot treat it as an investment loss or a charitable contribution.

What if I convert and then the market drops?

You still owe tax on the amount you converted, even if the account value falls afterward. If you converted $50,000 and the account drops to $40,000, you owe tax on the full $50,000. This is why some people do a "partial recharacterization" by moving a portion of the conversion back to a traditional IRA — but this option is no longer available under current rules, so timing conversions to avoid market downturns is important.

Does a conversion affect my Social Security taxes?

Yes, indirectly. A conversion increases your income for the year, which can push more of your Social Security benefits into the taxable portion. If you are over 62 and receiving Social Security, a large conversion might cause up to 85 percent of your benefits to become taxable instead of the usual 0 to 50 percent. This is another reason to model conversions carefully if you are on Social Security.

Can I convert just the earnings in my traditional IRA?

No. A conversion is an all-or-nothing transaction for the amount you choose to move. You cannot convert only the earnings and leave the contributions behind. However, you can convert a partial amount — for example, $25,000 of a $100,000 balance — and leave the rest in the traditional IRA.