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What is a “Roth conversion”?

What is a “Roth conversion”?

A “Roth conversion” is the action of converting pre-tax retirement assets (401(k), IRA, etc…) into Roth IRA assets. The converted assets are typically considered taxable income for the year of the conversion.

Why consider a conversion?

  • Your taxable income (and marginal tax bracket) is temporarily depressed, and you’d like to take advantage of the lower effective tax rate.
  • Tax rates may be higher in the future.
    • Under the 2017 Tax Cuts and Jobs Act (TCJA), the highest Federal income tax rate is currently 37%. This is set to revert back to 39.6% January 1, 2026.
    • For high earners, the net investment income tax (NIIT), also known as the Medicare surtax, is currently 3.8%, and the income thresholds for this tax are not indexed for inflation.
    • Your Medicare insurance premium is based on your taxable income (including tax-free interest), which includes taxable distributions from your retirement accounts. Qualified Roth IRA distributions are not taxable and have no bearing on your Medicare premium costs.
  • You don’t want your beneficiaries to pay income taxes on the required minimum distributions (RMDs).
    • The SECURE Act, if passed, may require certain non-spouse beneficiaries to distribute 100% of an inherited IRA within a shorter time period (5-10 years) instead of over their lifetime.

What are other methods for funding a Roth IRA?

  • Like a Traditional IRA, you may make annual contributions as long as you have sufficient earned income (and don’t earn too much!). The maximum contribution for the 2019 tax year is $6,000 ($7,000 if you are turning 50 or older during the year).
  • If your adjusted gross income is too high, you won’t be able to fund a Roth IRA directly. The 2019 income phase-out levels follow:
    • Single Filer: $122,000 – $137,000
    • Married Filing Jointly: $193,000 – $203,000
  • The “Back Door” IRA conversion is an indirect method for funding a Roth IRA. This method requires funding a non-deductible IRA and converting these assets to a Roth IRA. The “pro-rata” rule may apply if you have other IRA assets so please review this method thoroughly with a tax professional before proceeding.

Please call us if you’re considering a Roth conversion or would like to discuss the merits of a conversion given your unique circumstances.

All the best,

Your Team at Gamble Jones