Roth Conversion
IntermediateA Roth conversion is moving money from a traditional, tax-deferred retirement account in the United States, such as a traditional IRA or 401(k), into a Roth account, paying income tax on the amount converted in exchange for tax-free growth afterwards.
Traditional retirement accounts usually give tax relief on contributions, but withdrawals are taxed. Roth accounts work the other way round: contributions are made from taxed income, but qualified withdrawals are tax-free. A conversion switches money from the first type to the second.
The amount converted is added to taxable income in the year of conversion. For example, converting 50,000 for someone whose extra income would be taxed at 22% creates a tax bill of 11,000.
People often consider conversions in years when their income is unusually low, such as early retirement before pensions begin, or when they expect higher tax rates in the future. Paying the tax from other savings, rather than from the converted money, keeps more invested.
Conversions cannot be reversed. They may push income into a higher tax bracket and affect other income-based benefits. Converted amounts are also subject to a five-year rule before some withdrawals can be made without penalty. Because the decision depends on future tax rates, it involves judgment.
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