What a Roth conversion is

A Roth conversion is when you move money from a traditional IRA, SEP-IRA, straightforward IRA, or a 401(k) into a Roth IRA. You pay income tax on the amount you convert in that tax year, but once the money is in the Roth, it grows tax-free and you can withdraw it tax-free in retirement.

The core trade-off is straightforward: you pay taxes now to avoid taxes later. Whether that makes sense depends on your current tax bracket, what you expect your tax bracket to be in retirement, and how long the money will sit in the account before you need it.

Unlike regular contributions to a Roth IRA, there is no income limit on who can do a conversion. You can convert from a traditional IRA even if you earn too much to contribute directly to a Roth. You can also convert from a 401(k) if your plan allows it, though you typically need to be separated from service (no longer working there) or meet your plan's other conversion rules.

Key Takeaways

  • A Roth conversion moves pre-tax money into a Roth IRA and triggers income tax on the full amount converted in that year.
  • You report the conversion on Form 8606 when you file your tax return, and the IRS taxes it as ordinary income.
  • Conversions make the most sense when your current tax rate is lower than you expect it to be in retirement, or when you have a year of unusually low income.
  • If you have other traditional IRAs, SEP-IRAs, or straightforward IRAs, the IRS treats all of them as one pool for tax purposes, which can create an unexpected tax bill.
  • You can undo a conversion (called a recharacterization) only in limited situations, so understand the tax impact before you convert.

How the tax works when you convert

When you convert money from a traditional IRA to a Roth, the IRS treats it as a taxable distribution. The full amount you convert is added to your ordinary income for that tax year and taxed at your regular income tax rate — not at a special rate.

If you convert $50,000 from a traditional IRA, that $50,000 gets added to your W-2 wages, self-employment income, or other income. If you earn $75,000 and convert $50,000, the IRS sees your taxable income as $125,000 for that year. You owe tax on the full $125,000 at whatever your tax bracket is.

You report the conversion on Form 8606 when you file your tax return. This form tells the IRS how much you converted and how much of it was pre-tax money (which gets taxed) versus after-tax money (which does not). If you made after-tax contributions to your traditional IRA in past years, only the pre-tax portion and the earnings are taxable; the after-tax basis comes out tax-free.

The tax is due when you file your return for the year of the conversion. You do not pay it upfront when you move the money. Many people set aside money from their paycheck or other income to cover the tax bill, rather than having the conversion itself pay the tax.

The pro-rata rule and why it matters

If you own more than one traditional IRA, SEP-IRA, or straightforward IRA, the IRS treats them all as a single account for conversion purposes. This is called the pro-rata rule, and it can create a much larger tax bill than you expect.

Here is how it works: suppose you have a traditional IRA with $100,000 in pre-tax money and $20,000 in after-tax contributions (money you already paid tax on). You also have a SEP-IRA with $80,000 in pre-tax money. Your total across all accounts is $200,000, of which $180,000 is pre-tax and $20,000 is after-tax.

Now you want to convert $20,000 from the traditional IRA, thinking you will only owe tax on the $20,000. But the pro-rata rule says you cannot cherry-pick just the after-tax money. Instead, the IRS calculates the ratio of pre-tax to after-tax across all your IRAs: 90 percent pre-tax and 10 percent after-tax. So 90 percent of your $20,000 conversion ($18,000) is taxable, and only 10 percent ($2,000) comes out tax-free.

The pro-rata rule applies to traditional IRAs, SEP-IRAs, and straightforward IRAs. It does not explore to 401(k)s, 403(b)s, or other employer plans, which are treated separately. If you have a 401(k) with after-tax money in it, you can sometimes convert just the after-tax portion without triggering the pro-rata rule — but your plan must allow this, and the rules are complex.

When a conversion might make sense

A conversion is most useful when your tax rate this year is lower than you expect it to be when you retire. This often happens in a year when you have unusually low income — you took a sabbatical, you were laid off, you retired early, or you had a business loss.

Conversions also make sense if you expect tax rates to rise in the future. If you believe federal income tax rates will be higher in retirement than they are now, converting at today's rates locks in a lower tax bill. This is a prediction about future policy, so reasonable people disagree on whether it will happen.

Another reason to convert is if you want to leave money to heirs. Roth IRAs have no required minimum distributions during your lifetime, so the money can keep growing tax-free for decades. When your heirs inherit it, they can withdraw it tax-free (though they must empty the account within ten years under current rules). A traditional IRA, by contrast, forces you to take distributions starting at age 73, and your heirs owe income tax on those distributions.

Conversions can also help if you are close to income thresholds that affect other benefits. High income can reduce your Social Security benefits, increase your Medicare premiums, or disqualify you from certain tax credits. In some cases, converting in a low-income year and paying tax on the conversion can keep your income below a threshold and save you money overall.

When a conversion usually does not make sense

If you are in a high tax bracket now and expect to be in a lower bracket in retirement, converting is expensive. You pay tax at your current high rate to avoid tax at a lower rate later — a losing trade.

Conversions also do not make sense if you do not have money outside the IRA to pay the tax bill. If you convert $50,000 and owe $12,500 in tax, you should pay that $12,500 from a savings account or paycheck, not by having the IRA withhold it from the conversion. If you withhold from the conversion, you only move $37,500 into the Roth, but you still owe tax on the full $50,000. You end up paying tax on money that never made it into the Roth.

Conversions are also risky if you might need the money soon. Roth IRA withdrawals have a five-year rule: you must wait five years after your first conversion before you can withdraw the converted amount tax-free. If you convert and then need the money within five years, you will owe a 10 percent early withdrawal penalty on top of income tax.

How to report a conversion on your tax return

You report a Roth conversion using Form 8606: Nondeductible IRAs. Despite the name, this form is used for all conversions, not just nondeductible contributions.

Your IRA custodian (the bank, brokerage, or fund company that holds your IRA) will send you a Form 1099-R showing the amount you converted. You use this form and Form 8606 together to report the conversion to the IRS.

On Form 8606, you report the total value of all your traditional, SEP, and straightforward IRAs as of December 31 of the conversion year. You also report any after-tax contributions you made to these accounts. The form calculates how much of your conversion is taxable based on the pro-rata rule.

If you do not file Form 8606, the IRS may assume the entire conversion is taxable, even if part of it was after-tax money. This can result in paying tax twice on the same money — once when you made the after-tax contribution and again on the conversion. Filing the form protects you.

Can you undo a conversion?

You used to be able to undo a conversion (called a recharacterization) within a certain time frame, but that option is now very limited. As of 2018, you can only recharacterize a conversion if the IRS made an error or if your IRA custodian made a mistake in processing it. You cannot undo a conversion straightforward because the market went down or you changed your mind.

This means you should be confident about a conversion before you do it. Run the numbers with a tax professional if the amount is large or your situation is complex. Once the conversion is done and reported on your tax return, it is final.

Frequently Asked Questions

Do I have to convert my entire IRA at once?

No. You can convert part of your IRA and leave the rest in the traditional account. You can also do multiple conversions in the same year or spread conversions across several years. Each conversion is reported separately on Form 8606.

What happens if I convert and then the market drops?

You still owe tax on the amount you converted, even if it is now worth less. If you converted $50,000 and it drops to $40,000, you owe tax on $50,000. This is one reason to be cautious about converting right before a market downturn. You cannot undo the conversion to fix this.

Can I convert a 401(k) to a Roth IRA?

Yes, but only if your plan allows it and you meet the plan's rules. Most plans allow conversions only after you leave the job. Some plans allow conversions while you are still employed. Check with your plan administrator or HR department to see what your plan permits.

Does a conversion affect my Social Security benefits?

A conversion increases your income for that year, which can affect your Social Security benefits if you are claiming before full retirement age and still working. It can also increase your Medicare premiums if you are on Medicare. Run the numbers with a tax professional if you are close to these thresholds.

What is the five-year rule for Roth conversions?

You must wait five years from the year you convert before you can withdraw the converted amount penalty-free. If you convert in 2024 and withdraw in 2028, you are fine. If you withdraw in 2027, you owe a 10 percent early withdrawal penalty. The five-year clock resets for each conversion year.