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Financial Literacy

How to Execute a Roth Conversion

When you move assets from a traditional IRA into a Roth IRA, the switch can be to your advantage, but there are risks as well. Financial experts call this move a “Roth conversion.”

andrewwestlin

By Andrew Westlin
Financial Planning Professional, Betterment  |  Published: August 14, 2017

Converting from a Traditional IRA to a Roth IRA yields the tax advantages of a Roth account: paying taxes now rather than waiting until retirement.

Roth conversions do not make sense for everyone. If not done carefully, there can be some disadvantages. Consulting a tax professional is advised.


In the financial industry, when individuals want to transfer all or part of a Traditional IRA, SEP IRA, or SIMPLE IRA into a Roth IRA, we tend to call it a “Roth Conversion.” Why the name? Well, a “Roth Conversion” has a specific set of uses that help enable people to manage their taxes more effectively.

Since Betterment is not a tax advisor, we can’t provide actual tax advice on how a “Roth Conversion” would affect your specific tax situation, but there are generally three main benefits people point to when talking about whether a “Roth Conversion” would be a useful move for their finances.

Moving IRA types

3 Potential Benefits of a Roth Conversion

Taking Advantage of What a Roth IRA Does

At a basic level, when you execute a roth conversion, you’re moving from the benefits of having a traditional IRA to the benefits of having a Roth IRA—which means that you’re opting to pay taxes now rather than during retirement. Generally, with a Roth IRA, as long as you have had the account for more than five years and are over 59½ (or are disabled), you won’t have to pay any taxes when you withdraw money at retirement.

If you expect that your tax rate will be the same or higher than your current rate when you plan to withdraw money, paying taxes on that money now could mean a better after-tax return overall.

But why convert from traditional? Well, there are a few key limitations to traditional IRAs that might drive IRA holders to consider a Roth conversion. Here’s one.

Avoiding Required Minimum Distributions in Retirement

The IRS’ rules for a traditional IRA require that once a person reaches the age of 70½, they must begin taking required minimum distributions from their IRA every year. This means that at age 70½, a traditional IRA holder must begin withdrawing some money from their IRA each year and pay taxes on any amount that has not already been taxed

A Roth IRA does not require minimum distributions, so for some future retirees this could be a big advantage.

Moving to a Roth IRA When Your Income Exceeds Roth IRA Limits

Because Roth IRAs have income limits, not all investors can contribute to them directly. However, if you have a traditional IRA, you are allowed to contribute to it first and then convert those contributions into a Roth IRA afterwards, even if your income exceeds the IRS’ set limits.

Financial advisors often refer to this move as a backdoor Roth IRA, because it enables you to move your money into a Roth IRA by contributing first to a Traditional IRA. However, this switch can be complicated; you can learn more by clicking here.

The Disadvantages of a Roth Conversion

Of course, alongside the above benefits, there are also disadvantages of a Roth Conversion that investors should consider. For instance, typically, a Roth conversion has some kind of tax impact.

Some disadvantages of a Roth Conversion include the following:

  • You may have to pay income taxes now on conversion amounts that were previously deducted from your income. If your Roth IRA is with Betterment, we will not withhold these funds for you, so it requires a little bit of extra work on your end to make sure you settle up with IRS.
  • The converted amount will be added to your adjusted gross income for the year, and could potentially increase your tax bracket overall.
  • Taxpayers with incomes or an adjustable gross income (AGI) over $200,000 who file individually or $250,000 for married couples filing jointly could also be subject to a 3.8 percent Net Investment Income tax on the converted amount, so it might make sense to spread any conversions out across several tax years or delay converting until the “extra” tax can be avoided. Exceptions apply. You can read more about the tax here.​​

Listen Up Michiganders

If you live in Michigan, there are special requirements for completing your conversion.

Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a tax professional.

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How to Execute a Roth Conversion

How to Execute a Roth Conversion

When you move assets from a traditional IRA into a Roth IRA, the switch can be to your advantage, but there are risks as well. Financial experts call this move a “Roth conversion.”

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