Roth IRA Conversion Considerations
Roth IRA conversions remain as popular as ever. However, based on some recent questions we’ve received, it is apparent that folks don’t fully understand all the nuances of this transaction. Here are some of the basic concepts and items of consideration:
There are no income limits on Roth IRA conversions. Yes, there are income limits when making a Roth IRA tax-year contribution, but not on a conversion. A person could make a million dollars and still do a Roth conversion. Or, a person could be unemployed with zero income and do a Roth conversion. (If you reside in a low-income bracket, just be sure you have the money available to pay the tax on the conversion.) Back in the day there were income limits for Roth conversions, but those limitations have long since been repealed.
There is also no limit on the amount that can be converted. If you want to eat all the taxes due on a multi-million-dollar Roth conversion, go for it. For some people, this could be a wise strategy. Maybe their ultimate goal is to provide a tax-free inheritance to their beneficiary? Maybe they are sick of taking required minimum distributions (RMDs) and just want to rip the tax band aid off? Whatever the case may be, a single, gigantic Roth conversion is perfectly acceptable. (There have been proposals to limit conversion amounts, but such ideas have fallen on deaf ears.)
There is no such thing as a “prior year conversion.” There are prior-year Roth IRA tax-year contributions, but not conversions. For a conversion to count for a particular year, the funds must leave the traditional IRA by December 31. For example, if an IRA owner takes a distribution from his traditional IRA on December 31, 2024, and deposits those funds into a Roth IRA in early 2025 (within 60 days of the distribution), that will count as a valid Roth conversion for 2024.
A Roth conversion will generate a Form 1099-R showing the distribution in Box 1, and a Form 5498 showing the Roth conversion in Box 3. Continuing with the example above; the distribution in late 2024 will create a Form 1099-R for 2024. But since the rollover/conversion “crossed tax years” and wasn’t completed until early 2025, Form 5498 won’t be generated until 2026! Proper tax preparation is paramount to ensure the IRS knows what happened.
An important fact for anyone under age 59 ½ who does a conversion: taxes withheld on a Roth IRA conversion do not get converted. There is no age limit or penalty for doing a Roth conversion – only taxes due. But if a younger person has the taxes withheld from the IRA when doing the conversion, those taxes withheld are an early withdrawal and will trigger a 10% penalty on the money you are sending to the IRS!
One final interesting Roth conversion item: ordering rules. We know that Roth IRAs can consist of three different types of dollars – contributions, conversions, and earnings. Ordering rules dictate that Roth distributions follow that exact sequence when paid out. A person always has access to their Roth IRA contributions tax- and penalty-free. But be careful. A person could make a bunch of contributions to a TRADITIONAL IRA, and subsequently have a large amount of earnings in that traditional IRA. If this IRA were to be converted to a Roth IRA, those dollars would no longer be “contributions and earnings,” but would now be converted dollars within the Roth. Their “character” changed as they are now slotted into the Roth conversion bucket within the Roth IRA.
The Roth IRA conversion conversation can go on for pages and pages. (I didn’t even mention the 5-year Roth clocks!) Be sure to consider the laundry list of Roth conversion items before haphazardly diving in.
By Andy Ives, CFP®, AIF®
IRA Analyst
Ed Slott and Company, LLC
Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.