How to Do a Roth Conversion: A Step-by-Step Process
See how to correctly move funds to a Roth IRA. This guide explains the critical tax implications and procedural details before, during, and after a conversion.
A Roth conversion is the process of moving funds from a retirement account with pre-tax contributions and tax-deferred growth into a Roth IRA. In a Roth IRA, contributions are made with after-tax dollars, and qualified withdrawals are tax-free. This transfer of assets is a taxable event, and the total amount moved is added to your ordinary income for the year the conversion occurs. This move allows future investment growth and withdrawals to be shielded from taxes, but the decision requires weighing the immediate tax cost against long-term benefits.
Accounts Eligible for Conversion and Key Considerations
A wide array of retirement accounts are eligible for conversion to a Roth IRA. Common examples include Traditional IRAs, SEP IRAs, and SIMPLE IRAs. Employer-sponsored plans such as 401(k)s, 403(b)s, and governmental 457(b) plans can also be rolled over, typically after you have left the employer. A specific timing rule applies to SIMPLE IRAs, which require a two-year waiting period from the first contribution before they can be converted.
The primary issue to evaluate is the tax liability the conversion will generate. A substantial conversion could push you into a higher marginal tax bracket, increasing your tax bill. It is important to have funds available to pay these taxes, as using money from the conversion itself to pay the tax bill can lead to additional taxes and penalties.
The pro-rata rule governs the taxation of a conversion if you have made both pre-tax and after-tax contributions to any traditional, SEP, or SIMPLE IRAs. The IRS considers all of your non-Roth IRAs as a single entity for calculation purposes. You cannot simply choose to convert only the after-tax basis to avoid taxes, as the conversion is treated as a proportional distribution of your pre-tax and after-tax funds.
To illustrate, consider an individual with $100,000 across all their traditional IRAs, consisting of $20,000 in after-tax contributions and $80,000 in pre-tax funds and earnings. If this person converts $50,000 to a Roth IRA, the tax-free portion is calculated proportionally. In this case, 20% of their total IRA balance is after-tax money ($20,000 / $100,000). Therefore, 20% of the $50,000 conversion, or $10,000, would be tax-free, and the remaining $40,000 would be added to their taxable income.
The Roth Conversion Process Step-by-Step
The first step is to open a Roth IRA at a financial institution if you do not already have one. This account serves as the destination for the assets you intend to convert.
Next, you must choose the method for moving the money. The most common method is a direct rollover, also known as a trustee-to-trustee transfer, where your current financial institution sends the funds directly to the new institution managing your Roth IRA. This method is preferred because you never take possession of the money, which minimizes the risk of error.
An alternative is the indirect rollover, where the financial institution sends you a check. You then have 60 days from the date you receive the funds to deposit them into your Roth IRA. Failing to meet this deadline means the entire amount could be treated as a taxable distribution and, if you are under age 59 ½, may be subject to a 10% early withdrawal penalty. Some employer plans also offer an in-plan conversion, allowing you to move money within the same plan.
The final step is to formally initiate the conversion by contacting the administrator of your current retirement plan. You must provide clear instructions, specifying the exact amount you wish to convert and the chosen transfer method.
Tax Reporting for Your Conversion
After completing a conversion, the financial institution that held your original funds will send you Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, etc.” Box 1 of the form will show the gross distribution amount, which is the total value you converted.
Box 2a on Form 1099-R indicates the taxable amount of the distribution. This box may show the full amount as taxable, or it may be left blank, leaving the calculation up to you. It is your responsibility to determine the correct taxable portion. Box 7 contains a distribution code, such as ‘2’ if you are under 59 ½ or ‘7’ if you are over 59 ½.
To calculate the taxable amount of your conversion and report it, you must complete and file Form 8606, “Nondeductible IRAs.” This form is necessary for anyone who has made non-deductible contributions or is reporting a Roth conversion. Part II of Form 8606 is specifically used to determine the taxable portion of your conversion by applying the pro-rata rule.
You will use your records of non-deductible contributions and the year-end value of all your traditional, SEP, and SIMPLE IRAs to complete the calculation. The result from Form 8606 is then transferred to your Form 1040 on the line for IRA distributions. Properly completing Form 8606 ensures you pay the correct amount of tax.
Post-Conversion Withdrawal Rules
Once funds are in a Roth IRA, converted amounts have their own distinct timeline. A separate 5-year clock applies to each conversion you make. If you withdraw any part of the converted principal before five years have passed, the withdrawal may be subject to a 10% early withdrawal penalty. This penalty generally does not apply to distributions made after you are age 59 ½.
The five-year holding period for each conversion begins on January 1 of the year you made the conversion. For example, if you convert funds in November 2024, the five-year period for that specific amount starts on January 1, 2024, and ends on December 31, 2028. Withdrawing those converted funds before January 1, 2029, could trigger the 10% penalty.
This rule is distinct from the general 5-year rule for withdrawing earnings from a Roth IRA tax-free. For any earnings on your Roth IRA contributions and conversions to be withdrawn tax-free, two conditions must be met. First, you must be at least 59 ½ years old, and second, it must have been at least five years since you first opened and funded any Roth IRA. This rule for earnings is separate from the 5-year holding period that applies to each conversion.