What taxes are due on a Roth IRA conversion?

Do-overs are pretty rare in life, but one place you’ll find them is retirement accounts. If you sign up for a traditional IRA or a 401(k) plan then decide later you wished you’d picked a Roth IRA instead, you can switch it over, and it’s a fairly simple process. The catch? You’ll owe taxes.

While a Roth IRA conversion can be a valuable financial move — offering tax-free withdrawals in retirement —  it’s important to be mindful of the tax implications and plan accordingly, especially if you’re rolling over significant funds from a traditional IRA or 401(k).

What is a Roth IRA?

A Roth IRA is a retirement account that offers unique tax advantages. Contributions to a Roth IRA are made with after-tax dollars, but you won’t pay taxes on contributions or earnings in retirement. In contrast, contributions to traditional IRAs and 401(k)s are tax-deductible, but you pay income tax on the money — both your contributions and any earnings — that you take out during retirement.

You can also withdraw the money you put into a Roth IRA at any time without a penalty, though if you take out the earnings before age 59½, you’ll owe income taxes and a 10 percent IRS penalty.

What taxes are due on a Roth IRA conversion?

You’ll owe income tax on the amount you convert from a traditional IRA or 401(k) to a Roth IRA, since you’ve never paid tax on that income. The amount you convert is added to your gross income for that tax year. The higher the conversion amount, the more you’ll owe in taxes. This tax is based on your ordinary income tax rate in the year of the conversion.

So, rolling over a significant amount of money from a traditional retirement account to a Roth IRA could push you into a higher tax bracket, and you’d be forced to pay more on each incremental dollar of converted money.

If you’re converting a large amount of money, spreading your Roth IRA conversions over several years instead of doing it all at once can soften your tax blow. By converting smaller amounts annually, you may stay in a lower tax bracket while avoiding getting hit with a significant one-time tax bill in any given year. Making a conversion during a year when your income is unusually low is another way to save money on taxes.

If you convert a Roth 401(k) into a Roth IRA, you don’t have to worry about taxes because they both have the same after-tax treatment. You’ve already paid taxes on your contributions to a Roth 401(k) once, so you don’t have to pay those taxes again.You can use Bankrate’s Roth IRA conversion calculator to estimate the change in your total net worth at retirement if you convert a traditional IRA to a Roth IRA.

Example of a Roth IRA tax bill

Suppose your top marginal tax bracket is 24 percent, and you convert the entire $100,000 in your 401(k) to a Roth IRA. If the entire conversion amount is within the 24 percent bracket, your federal tax on the conversion would be $24,000. State income taxes may also apply. If you have a 5% state income tax rate, your state income tax would be $5,000.

The total calculation is:

• Federal income tax: $100,000 * 24% = $24,000
• State income tax: $100,000 * 5% = $5,000
• Total income tax: $24,000 + $5,000 = $29,000

In this example, your total income tax is $29,000. This calculation shows you may owe a significant amount when converting a $100,000 IRA.

Why spreading out your Roth IRA conversions makes sense

The primary reason for spreading out a Roth IRA conversion is that moving the full amount at one time may push you into a higher tax bracket. Remember that Roth IRA conversions are taxed as ordinary income. 

Using the previous example, converting $100,000 in a single tax year would push most people into the next tax bracket. In 2024, for instance, the 24% tax bracket is from $100,526 to $191,950 for single tax filers.

By spreading the conversion out over four or five years, you can potentially avoid crossing into the next tax bracket. Even if some of the conversion reaches the next bracket, only the dollars that exceed your current highest marginal tax rate will be taxed at a higher rate.

Beyond that, spreading out your conversion breaks up your tax bill into smaller chunks. Unless you plan on selling your investments, you must come up with cash to cover the conversion. Breaking it up means you won’t have to pay as much at one time.

What are the benefits of a Roth IRA conversion?

A Roth IRA conversion can have several benefits.

• Tax-free withdrawals: The biggest advantage of a Roth IRA conversion is its favorable tax treatment. While taxes are due at the time of conversion, qualified withdrawals after age 59½ are entirely tax-free, including contributions and earnings, as long as the account has been open for at least five years.
• May avoid higher tax rates in the future: A Roth IRA conversion can be advantageous if you expect to be in a higher tax bracket during retirement. Paying taxes now at your current (potentially lower) rate secures tax-free withdrawals when tax rates may be higher.
• Bypass income limits: Individuals who can’t contribute directly to a Roth IRA due to a higher income — such as single filers earning over $161,000 or married couples filing jointly earning over $240,000 in 2024 — can still benefit by converting through a strategy known as a backdoor Roth IRA.
• No required minimum distributions (RMDs): Unlike traditional IRAs and 401(k)s, which mandate minimum withdrawals starting at age 73, Roth IRAs have no required minimum distributions during the account holder’s lifetime. By converting, you avoid these mandatory distributions, allowing your investments more time to grow tax-free.

How to do a Roth IRA conversion

Converting a 401(k) or traditional IRA to a Roth IRA is a relatively simple process.

Here’s how to get started.

• Open a Roth IRA account: Start by opening a Roth IRA account at a financial institution. If you already have one, you can use it for the conversion.
• Contact your plan administrators: Get in touch with the financial institutions where the IRAs are held. Ask them about the requirements for moving your money to the new Roth IRA. If you’re staying with the same institution, the process should be easy.
• Submit the necessary paperwork: Figure out the paperwork needed for the conversion and submit it. Clearly state which assets are being moved over. If you manage your own funds, check your investment platform’s site for specific instructions.
• Wait for the conversion: Usually within a couple of weeks (or even sooner), the conversion to your Roth IRA will be complete.

You can convert your traditional IRA or 401(k) to a Roth IRA in a couple ways.

• An indirect rollover: An indirect rollover is where you receive a distribution from the old financial institution and then transfer it yourself to your Roth IRA within 60 days.
• A trustee-to-trustee rollover: A trustee-to-trustee rollover involves having your traditional IRA provider directly transfer funds to your Roth IRA provider on your behalf.

When filing taxes for the year of the conversion, use Form 8606 to inform the IRS about the rollover.

FAQs

• Can you convert an IRA to Roth without paying taxes?

  Money that goes into a Roth IRA is after-tax, so you cannot completely avoid paying taxes on money you convert to a Roth. However, reducing the amount you owe in taxes is possible. You can do this by spreading the conversion over several years, which reduces the tax you owe each year and may prevent you from moving into the next tax bracket.

• What is the downside of converting IRA to Roth?

  The main downside of converting a traditional IRA to a Roth IRA is that you will likely owe taxes on the conversion, potentially moving into the next tax bracket. Also, money must sit in a Roth IRA for five years before you can withdraw it tax-free, even after age 59½.

• How do I report a Roth IRA conversion on my taxes?

  You first need Form 1099-R detailing the conversion amount to report the conversion. Your IRA provider should send this form to you. Then, complete IRS Form 8606 filling in the amount shown on your 1099-R.

Bottom line

Any money moved from a traditional retirement account to a Roth IRA is considered ordinary income and will be taxed. Be prepared to pay the tax bill. If it’s a hefty amount, consider spreading the conversion over a few years to lessen the hit at tax time. A financial advisor can guide you through the conversion process, and help you decide if it’s the right move for you.

— Bob Haegele contributed to an update.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.