How to Perform a Roth Conversion

Roth conversion refers to moving assets from a traditional individual retirement account (IRA) to a Roth IRA. A Roth IRA is similar to a traditional IRA with one big distinction. Roth IRAs are funded with after-tax dollars, meaning the contributions are not tax-deductible. However, the money is tax-free when it is withdrawn at retirement. Roth IRAs are best suited for individuals that believe that their taxes will be higher in retirement than they are right now.

Several methods can be used to transfer money from a traditional IRA to a Roth IRA:

• • Indirect Rollover

    An indirect rollover is a simple way to transfer money from a traditional IRA to a Roth IRA. With a direct rollover, the money is transferred between accounts without any intervention from the account owner. However, with an indirect rollover, a distribution check is printed from the traditional IRA and contributed to the Roth IRA, often within 60 days.

    It is important to use caution when performing a Roth Conversion via an indirect rollover. While a direct rollover protects the retirement funds from income taxes and possible penalties for the tax year, an indirect rollover can leave the account owner owing income taxes and possibly excess contributions tax.

    Indirect rollovers are most commonly used when an employee leaves a job to start an independent business or changes jobs. When this happens, the employee usually has the option of a direct or indirect rollover. In the case of an indirect rollover, the employer usually withholds 20 percent of the pending amount to pay any taxes due.

    When the rollover process is complete, the money is returned as a tax credit for that tax year. If a person fails to deposit the money into the Roth IRA account, the balance is subject to tax and a 10 percent early withdrawal penalty if they are under age 59½.

  • Trustee-to-Trustee Transfer

    Another method of Roth conversion is called a trustee-to-trustee transfer. With this method, the account owner requests that the financial institution holding the traditional IRA funds transfer the money directly to the Roth IRA at a different institution. Trustee-to-trustee transfers are often faster than indirect rollovers. In addition, there is no mandatory 20 percent tax withholding.

    The transfer of funds from a traditional IRA from one trustee directly to another, whether it is at the account holder’s request or the trustee’s request, is not considered a rollover. Therefore, there is no distribution directly to the account holder and the transfer is tax-free. Since trustee-to-trustee transfers are not rollovers, they are also not subject to a one-year waiting period that is usually required between rollovers.

  • Same Trustee Transfer

    If an account holder’s traditional IRA and Roth IRA are maintained at the same institution, the same trustee transfer may be the most favorable option. With this method, the account holder may request that the trustee transfer money from the traditional IRA to the Roth IRA. Similar to a trustee-to-trustee transfer, a same trustee transfer can be completed quicker than a rollover.
    If the account holder does not yet have a Roth IRA, one can be set up with the same institution. When setting up a Roth IRA, there are a few things to consider. First, the account holder must determine how much they want to contribute and consider setting up automatic transfers.

    Roth IRAs also have annual limits and contributing more than the limit can lead to IRS penalties. In 2021, the annual limit on a Roth IRA is $6,000 for individuals under age 50 and $7,000 for individuals age 50 or older.

When To Perform A Roth Conversion

There are certain times when a Roth conversion may be performed to potentially reduce the amount of taxes owed. If possible, time the Roth conversion to complete in a year that the account holder falls into a lower tax rate than normal. It is also best to perform a Roth conversion when the balance of the traditional IRA is down, such as after the market takes a hit. If an account holder suspects that they will owe taxes, convert early in the year as this will create more time to pay.

Speak With An Experienced Wealth Manager

Roth IRAs offer various advantages, such as tax-free retirement income, easy early access to retirement funds, fewer withdrawal rules and better terms for heirs. In addition, nearly anyone can contribute to a Roth IRA. To be eligible to contribute the maximum contribution amount in 2021, a single person must make less than $125,000 and a married couple filing jointly must make less than $198,000.

For more information about how to perform a Roth conversion or to request a consultation for other wealth management services, reach out to an experienced wealth manager at Campbell Wealth Management.

This is intended for informational purposes only and should not be construed as tax advice. Consult your tax advisor regarding your situation.