When you transfer or roll over funds from one retirement plan to another, most of the time you do not pay taxes on the money until you withdraw it from the new plan. However, transferring funds from a traditional retirement plan like a 401(k) or IRA to a Roth IRA is treated differently.
This is because contributions to that traditional plan are typically made with pre-tax dollars, while contributions to a Roth IRA are made with after-tax dollars. Since you have not yet paid taxes on the contributions to the traditional 401(k) or IRA, this process is called a conversion, and the amount you convert to a Roth IRA is taxable.
Key Takeaways
Conversions from traditional retirement plans like 401(k)s or traditional IRAs to Roth IRAs are known as conversions, and the converted amount is subject to tax. There is no limit on the amount you can convert or roll over to a Roth IRA. While the IRS imposes a one-per-year limit on IRA conversions, it does not apply to Roth IRA conversions.
Roth IRA Conversions Are Exempt from the One-Year Annual Conversion Limit
You may have heard about the annual limits on IRA conversions, which apply to indirect conversions where a distribution from an IRA or retirement plan is paid directly to you, and you deposit it into another IRA or retirement plan within 60 days. You can only make one of these conversions every 12 months, regardless of how many IRAs you have. You can avoid the limit by choosing a transfer between trusts, where the funds are sent directly from one plan to another.
Note: Conversions from traditional IRAs to Roth IRAs are known as conversions and are exempt from the one-per-year annual conversion limit.
IRA Conversions Can Be Any Amount
Direct contributions to all IRAs are limited to a total of $6,000 per year or your taxable compensation for the year, whichever is less. The ability to contribute to a Roth IRA depends on your income and tax filing status.
Note: A Roth IRA conversion is not considered a contribution to the plan. Since tax laws changed in 2010, you have been able to convert any amount you wish (up to the full amount in your eligible plan).
Tax Implications of Roth IRA Conversions
Conversions from a traditional plan to a Roth IRA are called conversions because the tax treatment is different. Contributions to the traditional plan are tax-deductible, and distributions are taxable. In contrast, contributions to a Roth IRA are made with after-tax dollars, and distributions are tax-free.
If you contributed to a traditional plan, you have not paid any taxes on those dollars yet – which is why conversions to a Roth IRA are 100% taxable. You are converting the funds to after-tax dollars.
Since you must include the amount of the conversion in your gross income, the tax can be substantial. For example, converting a traditional 401(k) account worth $250,000 to a Roth IRA creates $250,000 of taxable income. Not only do you have to pay taxes on that $250,000, but adding that amount to your other income could push you into a higher tax bracket.
Before you begin a Roth conversion, you may want to consult with a financial or tax professional to fully understand the tax implications. They can help you devise a strong strategy for your circumstances.
Note:
One way to reduce the impact of a Roth IRA conversion on your tax bracket is to convert smaller amounts over several years, instead of converting the entire amount all at once.
Frequently Asked Questions (FAQs)
How can you convert a 401(k) to a Roth IRA?
There are three steps to converting a 401(k) to a Roth IRA. Open a Roth IRA account: First, you will open your Roth IRA account with a custodian, bank, brokerage, or other financial institution. You will fill out a form to open the account and provide information about your 401(k) plan. Notify your 401(k) plan administrator: The plan administrator will verify your eligibility to roll over funds from the 401(k). You will fill out a consent form and provide details about your Roth IRA custodian. Report the conversion on Form 1040: The plan administrator will send you a Form 1099-R to report the income on Form 1040 when you file your tax return.
What is an in-plan Roth IRA conversion?
You can convert funds from a traditional employer plan to a designated Roth account within the same plan if your plan allows it. Plans that may offer this feature include 401(k), 403(b), and governmental 457(b) plans. As long as your plan allows it, you can convert any eligible balances to the designated Roth account. However, in-plan Roth IRA conversions are taxable in the year they occur, so you will need to include the taxable amount in your gross income.
Would you like to read more content like this? Subscribe to The Balance newsletter for daily insights, analyses, and financial tips delivered straight to your inbox every morning!
Was this page helpful?
Thank you for your feedback! Tell us why! Other
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and maintain the accuracy, reliability, and quality of our content.
Internal Revenue Service. “Retirement Plan and IRA Distributions Rollovers.”
Internal Revenue Service. “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs),” see “General Limit.”
Internal Revenue Service. “Publication 590 Individual Retirement Arrangements,” page 7.
Internal Revenue Service. “IRA FAQs,” see “How can I convert a traditional IRA to a Roth IRA?”
Source: https://www.thebalancemoney.com/roth-ira-rollover-limit-5270328
Leave a Reply