What is a Roth IRA conversion?

Roth IRA is a type of retirement account that you fund with your post-tax income. You cannot deduct the contributions that you make to your Roth during the current year. When you open a Roth and make your contributions, the withdrawals that you make in the future that comply with the regulations and laws will be tax-free.

A Roth account may be especially beneficial if you anticipate that you will be in a higher tax bracket later when you will want to make withdrawals. If that is the case, then it makes sense to pay the taxes now rather than later during your retirement.

Roth IRA conversion statistics

In 2017, Americans held $810 billion in Roth IRAs. In 2016, 70 percent of Americans who opened Roth IRAs did so with contributions alone. An additional 9 percent of people used conversions to fund their accounts while another 17 percent of people only used Roth rollovers to open their Roth accounts.

People who choose to use conversions or Roth rollovers do so for a variety of reasons. They may believe that they will be in a higher tax bracket in the future or simply want to avoid having to pay taxes on their distributions once they retire. Others might like the flexibility of being able to make penalty-free withdrawals of a portion of the principal regardless of their ages.

Convert a Roth IRA

Why convert a Roth IRA?

There are several reasons why now might be a good time to consider a Roth IRA conversion. With the passage of the Tax Cuts and Jobs Act, individual taxes fell. However, these laws for individuals are set to sunset in 2025 unless Congress renews them, which means that your taxes may go up again in 2026. If the cuts expire, you may find yourself to be in a higher tax bracket beginning in 2026.

Another reason that you might find yourself to be in a higher tax bracket after you retire is the required minimum distributions that will kick in for your IRA at age 70 1/2. If your IRA balance has grown to a large amount by that time, the distributions can both move you into a higher tax bracket while also causing more of your Social Security benefits to be taxed. 

Finally, if you are married and your spouse predeceases you, you might then roll over his or her IRA into your own account. If you do, the required minimum distributions might also cause you to be in a higher tax bracket. 

These types of scenarios are why some people choose to roll over their traditional IRAs and employer-sponsored plans into Roth accounts or to complete Roth IRA conversions of the accounts. 

What are the benefits of a Roth IRA conversion?

A Roth IRA conversion allows you to enjoy the benefits of tax-free growth in the Roth account while also enjoying tax-free withdrawals after you retire. You should also take into account the tax rates in the state where you plan to retire. If they are higher, it might be beneficial to complete a Roth IRA conversion before your move so that you can do it while you have lower state tax rates.

Another benefit is the lack of required minimum distributions from a Roth IRA. You are not required to take distributions beginning at age 70 1/2 from your Roth. You are also able to continue contributing to a Roth account for as long as you want as long as you meet the income limits.

Roth IRA conversion details

To fully understand a conversion or Roth IRA rollover, it is important for you to understand all of the details of these types of accounts and how rollovers and Roth conversions work. Here is an overview of Roth conversions and rollovers so that you can gain a better idea of how they work and whether it is a good idea for you to consider them.

How to do a Roth IRA rollover

If you are wanting to complete a Roth rollover, there are a couple of ways for you to do it. You can open a Roth IRA account and then fund it from your old IRA or employer-sponsored plan.

You can complete a rollover by taking a distribution from your IRA. This means that the plan administrator will send a check to you. You then send the money to your new Roth account within 60 days. You can also opt to complete a trustee-to-trustee transfer. Under this method, you tell the fiduciary at the institution that is holding your traditional IRA to send a specific amount to the new financial institution that holds your Roth account. The trustee may then either send a check to you that is payable to the new trustee or send it directly to the trustee at the new financial institution.

The third method occurs when you are rolling over the balance in your traditional account to a Roth account at the same financial institution. With this method, you simply tell the trustee to move the amount that you want from your traditional IRA to your new Roth IRA.

Roth IRA conversion or rollover

Who should do a Roth IRA rollover

People who might benefit from an IRA rollover to a Roth account include those who anticipate being in a higher tax bracket when they start taking withdrawals. People who want to enjoy tax-free withdrawals when they are older can also benefit.

People who want to be able to contribute longer may also benefit by rolling over their savings to a Roth. Those who won’t need to make withdrawals to make ends meet in retirement might benefit from doing so because they can then build their Roth accounts to leave as a legacy for their family members.

When should you do a Roth IRA rollover?

Now is a good time for people to consider rolling over their IRA to a Roth. Since the passage of the TCJA, the tax rates are lower. While it is ostensibly possible for tax rates to fall more, tax rates throughout history have tended to rise. Currently, there is a window of time until 2026 during which tax rates will remain low.

If the tax rates are allowed to expire, the rates will go back up to their former levels. This means that you can take advantage of the lower tax rates now to enjoy lower taxes on the amount that you roll over and tax-free withdrawals during your retirement.

Another good time to complete a rollover to a Roth IRA is during a market downturn. This is because the value of the stocks in your IRA will be lower during a market downturn than they will be when the market rebounds. If you complete a rollover to a Roth IRA during a downturn, the value on which you will be taxed will be artificially low. In your Roth account, your assets will then be able to grow tax-free.

Roth IRA deadlines

If you plan to complete a Roth conversion, it is important for you to be aware of the Roth IRA deadlines. In order for your Roth IRA conversion to be effective for the tax year in which you will make qualifying contributions, your Roth account must be established no later than the tax filing deadline to comply with the IRA conversion to Roth conversion deadline.

To have your Roth IRA be effective for contributions, your Roth IRA application must be postmarked no later than April 15th of that year, assuming laws stay the same. This will allow you to both roll over your balance from your existing retirement account while also being able to make the maximum contribution of $5,500 for the 2018 tax year. You can then start making the $6,000 allowed contribution for 2019 after that with the additional $1,000 catch-up contribution.

Roth IRA conversion fees

Roth IRA tax implications, fees, and penalties

It is important that you understand the Roth IRA tax implications, fees, and penalties when you make withdrawals. These depend on your age at the time that you make a withdrawal. If you are under the age of 59 1/2, you can withdraw your contributions without being taxed or penalized. However, if you withdraw the interest that you have earned, you will be assessed taxes and penalties.

You can also be assessed penalties if you are 59 or younger and withdraw some of your earnings when your account is less than five years old. You might be able to avoid these penalties but not the taxes in the following situations:

  • You withdraw money to buy your first home up to a $10,000 lifetime maximum;
  • You’re unemployed and use the money to pay for health insurance;
  • You become disabled; 
  • You use the withdrawal to pay for certain qualified educational expenses; or 
  • Your distribution is made in periodic payments that are substantially equal.

If you are 59 or younger and your account is greater than five years old, you can avoid both taxes and penalties when you withdraw earnings for one of the previously stated purposes.

Roth IRA calculator

Prior to 2010, the only people who could open a Roth account were those who could meet the income limits. Beginning in 2010, that barrier was removed, allowing people who were affluent to open Roth accounts and to complete Roth conversions. Using a Roth IRA conversion can help you to figure out whether it would benefit you.

A Roth IRA conversion may allow you to roll over your existing account balances into your Roth account so that you can enjoy some of the tax benefits. However, you will not be able to make regular annual contributions to the account. This is referred to as creating a backdoor Roth IRA. To check if an IRA conversion to a Roth might benefit you, you can use the Roth IRA conversion calculator from Investopedia here.

Withdrawals from a Roth IRA

The withdrawals that you make from a Roth IRA are tax-free and penalty-free as long as you comply with the Roth IRA regulations as previously described. If you are 59 or younger and have had your Roth IRA account for more than five years, you can withdraw your contributions without paying taxes or penalties.

If you are 59 1/2 or older, you can withdraw both your contributions and your earnings without paying any taxes or penalties. If you do need to make a withdrawal of your earnings before you reach age 59 1/2, make certain that it is for one of the previously listed purposes to avoid penalties and taxes.

Roth IRA rollover/conversion options

There are several ways to complete a Roth conversion. You can complete a rollover through a trustee-to-trustee transfer between financial institutions. You can also take a distribution from your old account and use it to fund your Roth account within 60 days. If the conversion will occur within the same financial institution, you can simply direct the trustee to transfer funds from your IRA to your Roth IRA.

In addition to a rollover or a conversion, you can also convert to create a backdoor Roth IRA. A backdoor Roth IRA is a way for high-income people who otherwise would not meet the income limits to make Roth IRA contributions can still open a backdoor Roth IRA and roll over their existing retirement account balances to fund it.

Traditional to Roth IRA conversion

Converting a Traditional IRA to Roth IRA

To complete a backdoor Roth IRA conversion, there are a few steps that you should take. You will first need to open a traditional IRA account if you don’t already have one and make contributions to it. While you cannot make direct contributions to a Roth IRA if your income is too high, rollovers from other accounts don’t count.

This means that you can make contributions to a traditional IRA and then roll them over to your Roth account using one of the previously described IRA rollover methods to complete a recharacterization of IRA. For example, a traditional IRA is not income-limited, meaning that you can make up to $6,000 in contributions in a year even if your income is very high.

You can contribute $6,000 to the traditional IRA and then roll it over to your Roth account to create a backdoor Roth IRA contribution without running afoul of the laws or regulations. When you complete a conversion to a Roth IRA, the one-rollover-per-year rule doesn’t apply. This is how to create a backdoor IRA. There is no limit in how much can you roll over into a Roth IRA.

Conversion from 401k to Roth IRA

To complete a conversion from your 401k to a Roth IRA, you can first open a traditional IRA account. You can then direct the plan administrator for your 401k to complete a direct transfer of your funds into your traditional account. This is the first step to a 401k conversion to Roth IRA.

Next, you can open your Roth IRA account. You can then tell the trustee at the financial institution where your traditional IRA is held to send the funds to the trustee at the financial institution where your Roth IRA account is located. This is how you can convert 401k to Roth IRA.

SEP-IRA to Roth IRA

You can convert a SEP-IRA to a Roth IRA by completing either a direct transfer or a rollover. With a transfer, you tell the fiduciary of your SEP to send the funds to the institution at which your Roth account is held.

With a rollover, you have the money sent to you via check. You then must deposit the money into your Roth account within 60 days to avoid facing penalties. You will be assessed Roth IRA conversion taxes during the year that you make the conversion.

SIMPLE IRA to Roth IRA

To convert a SIMPLE IRA to a Roth IRA, it is important for you to follow the rules. You cannot complete a conversion of your SIMPLE IRA to a Roth IRA within the first two years following the date that you began participating in your employer’s SIMPLE plan.

If you violate the rule and send the money to your Roth IRA within that two-year time period, you will have to pay a 25 percent penalty in addition to the taxes that you will be assessed. This is because it will count as a distribution rather than as a rollover.

Other Roth IRA concepts

There are a few other Roth IRA concepts that you should know. We have addressed them below.

Converting an IRA to Roth after retirement

It is possible to complete a Roth conversion after retirement, but it is important for you to decide whether it makes sense for you to do so. There is no Roth conversion age limit, meaning that you are able to complete a traditional to Roth IRA conversion regardless of your age.

You will want to make sure that completing a traditional IRA conversion to Roth will not push you into a much higher tax bracket during the year that it occurs. If it does, more of your Social Security benefits may be taxed, you may face a large income tax bill, and you may be forced to pay a high Medicare surcharge.

Roth conversion ladder

Roth IRA conversion ladder is a method that you can use to access your retirement funds early so that you can retire well before you reach the normal retirement age. You can do this by contributing the maximum that you can to a tax-advantaged account at your job such as a 401(k).

When you leave your job, roll the money from your 401(k) into a traditional IRA. There aren’t any penalties for doing so. If you believe that you will need to access some of the money after five years, complete a rollover of that amount into your Roth IRA account. You will then need to wait for five years to comply with the Roth IRA conversion 5 year rule. Once those five years have elapsed, you can make withdrawals without incurring any additional taxes or penalties.

Impact on beneficiaries

If you are a beneficiary of an inherited IRA, it is possible for you to convert it to a Roth IRA. However, few beneficiaries do this because the amount of the conversion will be reflected on their income taxes for that year.

A conversion may make more sense if your current tax bracket is low and your expected future tax bracket will be higher. Then, it might be more advantageous for you to complete this type of conversion.

Partial rollovers for Roth IRAs

It is possible to complete a partial rollover to a Roth IRA. Some people choose to do this so that they can spread out the payment of taxes on their balances by making several rollovers in successive years from their traditional accounts to their Roth account.

This approach might make a lot of sense if your traditional account balance is very high. Instead of jumping up a couple of tax brackets, you can split the balance up over a few years so that your taxes will be more manageable.

Reversing a Roth IRA conversion

While it used to be possible to reverse a Roth IRA conversion, that is no longer the case. The Tax Cuts and Jobs Act nixed the ability of people to reverse their Roth IRA conversions once per year.

How investing with M1 Finance works

When you choose to invest with M1 Finance, you can open a customized account, including being able to maximize your retirement savings with free IRAs. You can then choose your investments according to your ability to tolerate risk in the percentages that you feel most comfortable with.

People are able to roll over their existing retirement accounts to their new Roth IRAs at M1 Finance by contacting the custodian of the old accounts and asking them to send a check. They can also set up automatic transfers so that they can make contributions without having to think about investing. M1’s intelligent automation allocates money from every deposit to maintain your target asset allocation and ensure your portfolio stays on track.

Why choosing M1 Finance can offer more benefits

When you choose M1 Finance, you will have access to a wealth of information along with smart technology to help your money to work harder for you. The digital tools help to automate the process and M1 Finance does not charge any commissions. You can view your investment portfolio to watch as your balance grows. To learn more about the benefits of M1 Finance, call us today at 312-600-2883. You can also get started investing now



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