Roth-to-Roth Rollovers & Transfers

Distributions from one Roth IRA can be rolled over tax-free to another Roth IRA by following the general rules for IRA rollovers: re-deposit of funds within 60 days and no more than one rollover per year from the same IRA. Similarly, assets held in a Roth IRA can be transferred directly from trustee to trustee, just as with traditional IRAs. There is no limit on how frequently direct transfers may occur.

Converting a Traditional IRA to a Roth IRA

Special rules apply when assets are moved from a traditional IRA into a Roth IRA — a so-called “conversion.” Conversions must be accomplished within the 60-day limit, but the law waives the once-per-year rule for conversions from traditional to Roth IRAs.

Income Limits Eliminated

Prior to 2010, conversions were restricted to taxpayers with adjusted gross income under $100,000. That restriction was permanently eliminated beginning in 2010. Today, any taxpayer — regardless of income — may convert a traditional IRA to a Roth IRA. The only filing status restriction is that taxpayers who are married filing separately generally may not convert (unless they live apart from their spouse for the entire tax year).

How to Convert

Individuals may make a conversion without physically taking a distribution by simply notifying the IRA trustee. A conversion may also be made via a direct trustee-to-trustee transfer. If only part of an IRA balance is converted, the Roth IRA amounts must be held separately from traditional IRA balances.

Tax Treatment of Conversions

The taxpayer who converts from a traditional account to a Roth IRA must pay ordinary income taxes on the amount converted. Technically, the conversion is a distribution from the traditional IRA (and a subsequent redeposit into the Roth IRA) and is taxed accordingly. However, the 10% early withdrawal penalty does not apply to the conversion itself.

Important — 5-Year Holding Period for Converted Funds: The 10% penalty on premature withdrawals does apply if converted funds are subsequently withdrawn from the Roth account within five tax years of the conversion, or prior to age 59½, death, or disability. Each conversion carries its own separate 5-year holding period. Without this rule, funds could be converted from a traditional IRA simply to avoid the penalty tax.
Roth 401(k) and Roth 403(b) Plans: Assets in Roth 401(k) and Roth 403(b) plans, funded with after-tax dollars, can be rolled over or transferred to a Roth IRA. These are not subject to income taxation when converted, since contributions to those accounts were already taxed. The five-year holding period is based on when the Roth IRA was first established. Note: assets in a Roth IRA may not be rolled over or transferred back into a Roth 401(k) or Roth 403(b) plan.
Rolling Qualified Plan Assets Directly into a Roth IRA

The tax code permits taxpayers to roll over assets from a non-Roth employer retirement account (such as a traditional 401(k) or 403(b)) directly into a Roth IRA in a single step. Taxes are owed on the pre-tax portion of the conversion in the year the rollover is completed — but no penalty applies to the conversion itself (the 5-year rule still governs premature withdrawals of converted amounts thereafter).

The Decision to Convert

The decision whether to convert assets to a Roth IRA is complex, and each individual must evaluate his or her unique situation. The most important factors to consider include:

  • Current vs. future tax rates: Does the taxpayer foresee being in a higher tax bracket in retirement? If so, paying taxes now at a lower rate may offset the certainty of a current tax bill. Given ongoing federal budget pressures and unfunded obligations in Social Security and Medicare, many analysts expect tax rates to rise in the future.
  • Bracket impact in the conversion year: Will the added income from the conversion push the taxpayer into a higher bracket — or cause Social Security benefits to become taxable?
  • Impact on other tax benefits: Many deductions and credits are phased out at higher income levels, as is financial aid for higher education. A large conversion could temporarily reduce or eliminate these benefits.
  • Ability to pay taxes from outside funds: The conversion is most advantageous when the taxpayer can pay the resulting tax bill from non-IRA funds, allowing the full converted amount to remain in the Roth IRA and grow tax-free.
  • Time horizon: Younger taxpayers with more years of tax-free growth ahead generally benefit more from conversion than those who are near retirement and will begin withdrawals soon.
  • Estate planning: Roth IRAs have no required minimum distributions during the owner’s lifetime, making them powerful tools for passing wealth to heirs.
Backdoor Roth IRA: High-income taxpayers who exceed the Roth IRA income limits for direct contributions may still fund a Roth IRA indirectly by making a nondeductible traditional IRA contribution and then converting it to a Roth IRA. This strategy — sometimes called a “backdoor Roth” — is legal but should be discussed with a tax professional, particularly if the individual holds other traditional IRA assets (due to the pro-rata rule).
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