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Roth Conversion Season Is Here

(For an explanation of pre-tax “traditional” versus post-tax “Roth” retirement accounts, I recommend starting here. Importantly, my website disclosure statement can be found here.)

Roth conversions are in the air

It’s that time of year again. Holiday lights lining the streets, consumer madness, and of course: Roth Conversions. For those new to the subject, a Roth Conversion is where you transfer money from a pre-tax account, such as an IRA or 401(k), into a post-tax Roth account, like the Roth IRA and Roth 401(k). 

Such a transfer is known as a Roth Conversion, and importantly, it is different from a backdoor, after-tax conversion outlined in Is there a FIRE Backdoor?

But why in the world would someone move money from a pre-tax account to a Roth one? After all, they will have to pay income taxes! 

Well, that is the point. You see, the US income tax system operates within graded brackets:

Thus, there are ranges within each tier regarding how much money you can make before every subsequent dollar becomes taxed at a higher amount. 

As a result, if you fall into the 12% single-payer bracket above with an income of $30,000 after deductions, you have $10,525 that you can convert before any income is taxed at the higher 22% bracket. And notably, conversions count as income.

$40,525 – $30,000 = $10,525

Important note: Don’t forget to subtract your deductions from your income before using this scale! Your adjusted gross income (AGI) will likely be used with the graded brackets above for those doing their taxes. AGI = All income sources minus all eligible deductions. If you are unsure what bracket you fall into, consult a tax professional.

But why do I care about converting “up” to the maximum permitted amount in my income tax bracket?

Great question! You see, we will never know what future tax rates be. They could be more significant than they presently are or less. Nobody knows, but with the increasing national debt, someone will have to pay for it.

Thus, the first reason is the certainty conversions provide. If you have a lower income tax year or fall into a bracket that you think will be less (or the same) than your retirement income, then it could make sense to convert! 

The second reason is that for those pursuing financial independence and/or early retirement, Roth conversions unlock your pre-tax retirement dollars from the standard 59.5 age withdrawal requirement. The end result is that you can withdrawal your retirement dollars early without penalty. However, there is a five-year waiting requirement, which I outlined previously in Roth Ladders: Climb for Freedom

Fun fact: Roth ladders involve converting pre-tax dollars to Roth dollars each year for x-number of years, creating a stream of dollars you can access for early retirement income while strategically not overpaying taxes.

But I make too much money to do a Roth Conversion

No, you don’t! There is no income requirement to make a Roth conversion; that only applies to Roth contributions. However, if you are in a higher tax bracket, consider if it truly makes sense to do a pre-tax to Roth Conversion by weighing your potential income in retirement and the likelihood of a future tax increase. 

Also, suppose you plan to live in a no-income-tax state in retirement and currently live in a state with income taxes. In that case, you should likely reconsider doing a conversion unless you expect federal income taxes to be that much higher in retirement.

How do I do a Roth Conversion?

It varies with each brokerage firm, but searching around for instructions on their website should answer the question. If you are still unsure, give them a call and ask for help!

When do I have to do a Roth Conversion by

Usually, Roth Conversions must be made by 12/31 of each year. However, you must initiate them several days before 12/31 to complete the conversion with specific accounts. Thus, try to do your conversions no later than 12/24.

(When I worked as a 401(k) advisor, many clients would call on 12/31 to do a conversion, only to find out that their 401(k) takes three days to process conversions, meaning they were out of luck.)

Don’t forget to have the extra tax money set aside

Usually, taxes are not remitted to Uncle Sam when doing a Roth Conversion. Instead, you have to pay them when you file the following year. However, some brokerages will remit them for you, but this only applies to IRAs. 

Thus, if you don’t have taxes remitted at the time of conversion, be sure to have the extra funds set aside to pay Uncle Sam to come on April 15th the following year. Otherwise, you could owe money that you don’t have ready to pay!

Final thoughts on conversions

In closing, Roth Conversions can be a great year-end strategy as 2021 draws to an end due to their ability to lock in tax rates and free your retirement dollars from penalties. Will you process a conversion this year? 

If so, is it to lock in a lower tax bracket? Or perhaps so that you can access your retirement dollars early? Regardless, let me know in the comments below why you are or aren’t processing a Roth Conversion this year, and as always, have a great day!


Mile High Finance Guy

finance demystified, one mountain at a time






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2 thoughts on “Roth Conversion Season Is Here”

  1. I tried to get ahead of this for first time conversion trad to roth ira, but I found myself w/estimated pension pymnt ($60k/yr), & 401k ($84k/yr; actually,i’m a ret USG emplyee in TSP system), but my MFunds have capital gains paying out and i’m not sure of those numbers to use in an estimate before end of year to know how much room i have to convert in the 24% bracket? I converted my ira to roth several yrs ago before ret in two lumps/2 yrs (w/big tax pymts >$50k), but now yrs later, my wifes is over $1M in trad ira, and i want to start moving that $ over. I’m 60, she’s 55, both basically FIREd. Any quick help idea? I guess i should have called the MF for my actual cap gains #s?

    1. Jim

      Longterm capital gains, while taxed at a lower rate, are included in your AGI. Thus, they will come into play when converting up to the 24% bracket. You will want to determine your estimated AGI for 2022. Once you know this, you can do subtraction to determine your conversion amount. I like using this tool [located here] to determine my AGI (which will be line 4, Taxable Income). Be sure to include any qualified dividends (i.e., ones that are reported annually on your 1099-DIV, in the appropriate place and to include capital gains in the included sections). While you may not know 2022 LTCGs and DIVs, you can make estimates. However, waiting until December is usually the safest bet. Also, you can find the 2022 tax tables here [Link]. I hope this helps, Jim!

      Olaf, the Mile High Finance Guy

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