10 Roth IRA Conversion Questions and Answers

Converting traditional IRA (Individual Retirement Account) funds to a Roth IRA can be a powerful tax savings opportunity. Here are some frequently asked questions on the topic:

1. What is the main difference between traditional IRA and Roth IRA? 

A traditional IRA provides tax-deferred growth. A Roth IRA offers tax-free growth.

2. What’s the tax cost of converting to Roth? 

The value of the conversion is ordinary income. The tax cost will depend on your marginal tax rate.   Some taxpayers could pay as high as 40% tax; others may pay nothing.  Many will pay a rate somewhere in between.    Work with your tax/financial advisor to watch for opportune times to convert to Roth.

3. What do you mean by “opportune times”?

Think of it as tax bracket management. If you have a lower income year and have room in a lower tax bracket, you can fill that bracket up with Roth conversion. Might you have some unused deductions?   Opportunity depends on your situation. Some retirees may benefit by converting to Roth each year before being subject to higher Medicare premiums or before required IRA distributions force them into a higher bracket.

4. Does a Roth conversion make sense for everyone? 

No.  A general rule of thumb is comparing what tax rate you would pay today vs. tax rate in retirement.

5. Can I do a partial conversion?

Yes!  Most likely you’ll only want to convert a portion of your IRA to avoid going into higher brackets.

6. Should I request that tax be withheld on a conversion? 

No. The withholding would be treated as a distribution and would not be part of the conversion. Make estimated tax payments or adjust withholdings from other income sources to cover taxes.

7. Can I undo a conversion? 

Yes, this is called a recharacterization, but it must be done before the extended due date of the tax return.  (i.e. October 15th of the year following the conversion)

8. Why would I want to recharacterize (undo) a conversion?

One reason to “undo” is because the value of the Roth decreased significantly (why pay tax on a $50,000 conversion that is now worth $44,000). A second reason is because the optimal amount to fill a tax bracket was less than you thought (e.g. You thought you could bring in $50,000 of income at the 15% tax rate, but it turns out you only had $25,000 of room. You can undo 50% of the conversion.)

9. Can I convert my work 401(k) to Roth 401(k)? 

Yes, you can, but your plan must allow for it. It’s very important to note that a recharacterization (“undo” option) is not available for 401(k) conversion.

10. Is there anything else I should know?

We’ve covered the basics here and only began to touch on considerations. Next, we’ll focus on Roth conversion strategies involving multiple conversions and different investments; that and more in next month’s article.

How Can DHJJ Financial Advisors Help?

Do you have a question about a Roth conversion? Contact the DHJJ Financial Advisors at 630.420.1360.