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Converting to a Roth IRA

A Roth conversion occurs when you move assets from a Traditional, SEP or SIMPLE IRA (collectively referred to as a Traditional IRA in this article) or qualified employer sponsored retirement plan (QRP) — such as a 401(k), 403(b), or governmental 457(b) — and reposition them to a Roth IRA. When converting your before-tax savings, you’re including the converted amount as ordinary income on your taxes now to get the benefit of tax-free potential growth in a Roth IRA later.

Key Benefits:

Roth IRAs offer a number of potential advantages over Traditional IRAs. Traditional IRAs allow for tax-deferred growth of retirement assets, with taxes being due when distributions are taken. Distributions of Roth IRA earnings are tax-free, as long as the Roth IRA has been open for more than five years and you are at least age 59 1/2*, or as a result of your death, disability or using the first-time homebuyer exception. Distributions may be subject to a 10% IRS tax penalty if taken prior to age 59 1/2. Other features include:

  • With a Roth IRA, unlike Traditional IRAs, you do not have to take required minimum distributions (RMDs) during your lifetime.
  • A Roth IRA can be used as an estate planning tool because the assets can be passed on tax-free to your beneficiaries.
  • Tax diversification of retirement assets allows for more flexibility to manage taxable income in retirement.

Generally, a Roth IRA conversion makes sense if you:

  • Won’t need the converted Roth funds for at least five years.
  • Expect to be in the same or a higher tax bracket during retirement.
  • Can pay the conversion taxes without using the retirement funds themselves.
  • May not need the funds for retirement and may want to transfer them to your beneficiaries.

A Roth IRA conversion may not be appropriate if you:

  • Are not sure what your tax situation will be like this year because once you convert you cannot recharacterize or "undo" the conversion.
  • Have to deplete other assets to pay the taxes due on the conversion.
  • Are pushed into a higher tax bracket due to the amount you convert.
  • Will be in a lower tax bracket in retirement.
  • Will be relocating to a state with no or lower state income tax.
  • Are wanting to convert your RMD because RMDs cannot be converted. You must first satisfy your RMD and then complete a Roth conversion.

Before converting there are a few things to consider:

  • You cannot recharacterize. The Tax Cuts and Jobs Act signed into law December 2017 has eliminated the ability to recharacterize a conversion to a Roth IRA. Roth conversions completed in 2017 will continue to be eligible for recharacterization through October 15, 2018 (tax filing deadline, plus automatic extension), as outlined under the previous tax statutes. Roth IRA conversions made on or after January 1, 2018, cannot be recharacterized.
  • The availability of funds to pay income taxes. The benefits of a conversion are increased if the income taxes due can be paid out of non-retirement assets. 
    • To help manage your tax liability, you may choose to convert just a portion of your assets. There is no limit to the number of conversions you can do, so you may convert smaller amounts over several years.
  • Your time horizon. Generally, if you will need the funds within the next five years, a Roth IRA is not a good choice. This is because a five-year waiting period is required if you are under age 59 1/2 before you can distribute the converted amount  penalty free. The longer the assets in the Roth IRA can be left untouched, the greater the benefit of tax-free potential earnings accumulation.

Eligibility

Anyone is eligible to convert regardless of their income or tax filing status.

To discuss the potential advantages of Roth IRAs and Roth IRA conversions with a Wells Fargo retirement professional, call 1-877-493-4727. To determine whether a Roth IRA conversion is right for you, talk to your tax advisor.

Converting to a Roth IRA may seem like a lot of work, but we can make it easy. Just call a Wells Fargo retirement professional at 1-877-493-4727, and we’ll work with you throughout the conversion process.

Here’s what to expect:

Step 1 – Contact a Wells Fargo retirement professional at 1-877-493-4727 to initiate your conversion request and get an overview of the process.

Step 2 – Our team will help you open a new Roth IRA account, fill out the appropriate paperwork, and answer any questions you may have.

Step 3 – An account form will be sent to you (emailed, faxed, or mailed) to initiate your conversion.

  • Whether you’re converting a Wells Fargo Traditional IRA, an IRA from another financial institution, or an employer-sponsored retirement plan, such as a 401(k), we’ll walk you through the process to make sure all of your questions are answered.

Step 4 – Return the paperwork (email, fax, or mail) to complete your request.

Frequently asked questions about Roth IRA conversion

What is a Roth conversion?

A Roth conversion is the process of repositioning your current tax-deferred assets in a Traditional IRA or employer-sponsored retirement plan, such as a 401(k), to a Roth IRA. 

What type of retirement accounts can I convert to a Roth?

In addition to Traditional IRAs, funds in qualified employer plans (QRPs) such as 401(k)s, 403(b)s, or governmental 457(b)s that are eligible to be rolled over may be converted to a Roth IRA.

Will I owe taxes on my conversion?

A conversion of after-tax amounts will not be subject to income tax.  Any before-tax portion converted will be included in your gross income for the year.

Can I pay the taxes from my conversion from the retirement funds?

While it is possible, it generally does not make sense to use the retirement assets to pay the taxes. If you are under age 59 1/2, the amount distributed to pay taxes may be subject to the 10% IRS tax penalty. Plus, those funds would no longer be growing tax-free within the Roth IRA. It’s suggested you use assets outside of retirement accounts to pay any taxes resulting from the conversion. 

Do I have to convert the entire amount in my Traditional IRA or QRP?

No. You may convert just a portion of your assets, and there is no limit to the number of conversions. To help manage the taxes due on each conversion, you may convert smaller amounts over several years. Keep in mind, each conversion has its own five-year waiting period to avoid the 10% IRS tax penalty if you are under age 59 1/2.

What if I change my mind? Can I undo my conversion?

The Tax Cuts and Jobs Act signed into law December 2017 has eliminated the ability to recharacterize a conversion to a Roth IRA. Roth conversions completed in 2017 will continue to be eligible for recharacterization through October 15, 2018 (tax filing deadline, plus automatic extension), as outlined under the previous tax statutes. Roth IRA conversions made on or after January 1, 2018, cannot be recharacterized.

I have after-tax contributions in my Traditional IRA, can I convert just that portion to a Roth?

No, you cannot convert just the after-tax dollars within your Traditional IRA; instead the IRS requires that you follow the pro-rata rule.  In simplest terms the pro-rata rule is used to determine how much of a distribution or conversion is taxable when you have both after-tax and before-tax dollars in any of your Traditional, SEP and/or SIMPLE IRAs.  That means each distribution from the account contains some portion of before-tax and after-tax money. Your tax advisor can help you with this calculation.

Are the income eligibility limits still in place to make an annual contribution to a Roth IRA?

Yes. The income limits for annual contributions are still in effect, so it’s possible to take advantage of a Roth conversion but not be eligible to make an annual contribution. Since there are no income eligibility limits for conversions, however, one common strategy is to make a non-deductible contribution to a Traditional IRA then convert it to a Roth IRA.  This may not be an appropriate strategy if you have other Traditional, SEP, or SIMPLE IRA balances, as the Pro Rata Rule (see above) would apply. Please consult a tax advisor to see if this strategy would work for you.

Is there an early-withdrawal penalty on the conversion?

No, there is no early-withdrawal penalty on the amount converted. If you take a distribution, or elect tax withholding to pay for the taxes, and are under age 59 1/2, you may owe the 10% IRS tax penalty.

When am I eligible for tax-free distributions?

Earnings are tax-free if the Roth IRA has been open for more than five years and:

  • You are at least 59 1/2 years old, or
  • You are disabled, or
  • You are using the first-time homebuyer exception ($10,000 lifetime limit), or
  • Your beneficiaries are taking distributions due to your death

Can my beneficiary distribute the funds tax-free?

Yes, as long as it’s been more than five years since the first tax year the Roth was funded by either a conversion or an annual contribution. This is one of the primary benefits of a Roth IRA, especially if beneficiaries take RMDs over their lifetime.

Where can I find more information on Roth conversions?

Consult with your tax advisor for more information. Call 1-877-493-4727 to speak to a Wells Fargo retirement professional today.

We’re here to help

Call us 1-877-493-4727