Converting Your Traditional IRA to a Roth IRA
Two of the most common types of IRAs are the traditional IRA and the Roth IRA. While both are Individual Retirement Accounts, they offer different features and benefits.
How so?
With a traditional IRA, your contributions are pre-tax and may be tax-deductible. The funds in a traditional IRA account will not be taxed until you take distributions, at which point the withdrawals are generally taxed as income.
When you have a Roth IRA, you invest money after paying taxes, allowing those funds to grow tax-free. You can take distributions free of tax in your retirement years if you meet all required conditions.
There are three key differences between these two types of IRAs that you should keep in mind:
- Taxes: Roth IRA contributions are made with after-tax money, the funds grow tax-free, and withdrawals in retirement are also tax-free. With traditional IRAs, contributions are made pre-tax, earnings grow tax-deferred, and you’re taxed on withdrawals (which ideally happen during retirement.)
- Income requirements: To contribute to a Roth IRA account, you need to earn below an IRS-designated income level. On the contrary, anyone with any income over age 18 can contribute to a traditional IRA (still, there are income limits for how much can be considered tax-deductible).
- Required Minimum Distributions: Roth accounts don’t require you to withdraw a minimum amount in your retirement years, whereas traditional IRAs stipulate an RMD once you turn 73. An RMD is a minimum amount you must remove from your IRA, and that amount passes through your tax return.
Many investors will do a Roth IRA conversion when they think their tax rate will be higher in retirement than in the present or if they plan to leave money to beneficiaries.
How can you change from one account type to another? You can perform a Roth IRA conversion if you have an existing traditional IRA. Since you’ll be converting from a pre-tax to a post-tax account, converting a traditional IRA to a Roth IRA has some tax implications:
- You’ll pay federal income taxes on the full conversion amount.
- You won’t pay federal income taxes on future earnings in your Roth IRA if you meet all requirements and you’ve had your account open for at least five years.
Benefits of Fidelity Roth Conversions
Converting your traditional IRA to a Roth IRA with Fidelity can bring benefits to investors, such as:
- Flexibility and control over your retirement savings: A Fidelity account allows you to choose your investments without being limited to a fixed menu (like with a 401(k)).
- Tax-free growth potential: Like all Roth IRAs, working with Fidelity Investments will allow you to grow your funds tax-free.
- No Required Minimum Distributions (RMDs): When you convert from a traditional IRA to a Roth IRA, you won’t have any RMDs in retirement.
- Access to a broader array of investment options: Fidelity IRAs and Fidelity Brokerage Services LLC, in general, offer investors extensive options so they can choose to invest in ways that align with their financial goals.
- Convenience and simplicity of managing your retirement accounts in one place: Using fidelity.com, you can manage all of your retirement accounts in one place. What’s more, you can use Fidelity’s tools to track your broader finances, request Roth conversions, and more.
Deciding if a Roth Conversion is Right for You
If you have a traditional IRA, how can you decide if a Roth conversion is suitable for your circumstances? You may want to start by considering these four main factors:
- Taxes: When you convert, you’ll pay federal income taxes on the total amount. But there won’t be any taxes on future earnings or withdrawals (as long as you meet eligibility requirements like being over 59 1/2 and having the account open for at least five years).
- Time: The benefits of holding a Roth IRA increase the longer you have that account, and you need to have the funds in the account for at least five years before you can access the earnings portion penalty-free.
- Cost: Since you’ll be paying federal income taxes on any amount you convert, make sure you can afford to pay the taxes due.
- Required Minimum Distributions (RMDs): Roth IRAs don’t have RMDs during your retirement years, whereas traditional IRAs have minimum distributions beginning at age 73.
Here are common situations that drive investors to perform a Roth IRA conversion.
Consider a Roth conversion if:
- You think that your income tax rate will be the same or higher in retirement than it is today.
- Your taxable income this year is lower than usual.
- You have accounts that lost value in a recent market correction.
- You plan to leave your assets to your beneficiaries in a tax-efficient way.
- You don’t plan to withdraw earnings from your Roth IRA for at least five years.
As always, when making an important financial decision, speak to a tax advisor to determine the potential consequences of your actions.
Considerations for Roth IRA owners
Roth IRAs have different features than traditional IRAs, so remember these key characteristics before you convert:
- Roth IRA distributions are tax and penalty-free if you meet all eligibility requirements. Additionally, your account must be at least five years old, or you’ll be subject to a 10% early withdrawal penalty on the earnings portion of your account balance.
- Contributions can be withdrawn at any time, tax and penalty-free.
- There are no Required Minimum Distributions (RMDs) for your Roth IRA.
- Because you make after-tax contributions to your Roth IRA, you won’t be subject to an additional tax liability when you withdraw the funds in retirement.
FAQs
How do I convert my traditional IRA to Roth?
When investing with Fidelity, you follow a simple online process to convert a traditional IRA to a Roth IRA. If you currently don’t invest with Fidelity and want to convert your IRA to a Roth there, you must open both a traditional and Roth IRA with Fidelity, and complete the online process to convert your existing IRA into a Roth.
How much tax will I pay if I convert my IRA to a Roth?
Because Roth conversions are taxable events, you’ll owe income tax on the entire amount you convert from your traditional IRA to your Roth IRA in the year you make the move. The amount of tax you ultimately owe will depend on your income tax bracket and corresponding income tax rate, which takes into account all of your other income for that tax year.
Can I Roll Over my Fidelity 401(k) to a Roth IRA?
If you have a Roth 401(k) account, you can roll funds into a Roth IRA tax-free through Fidelity by completing an online process. While both types of accounts allow you to invest in mutual funds, remember the income limits and contribution limits vary between IRAs and 401(k)s. You’ll also have access to a wider range of investment options inside a Roth IRA, which include ETFs and single stocks.
Need Help Managing Your 401(k) to Roth IRA rollover?
Rolling a 401(k) to a Roth IRA with Fidelity has many potential benefits. You can gain control over your retirement, grow tax-free earnings, eliminate RMDs, and access various investment options.
However, managing the tax requirements behind a Roth conversion can be challenging during a job change or an approaching retirement. It’s important to work with a tax professional to get the right tax advice as it relates to Roth IRA conversions.
If you do choose to convert, working with a trusted partner to manage the process is almost universally beneficial. Capitalize makes moving your retirement accounts seamless, and we help you ensure you meet all financial regulations along the way.
Get started with us so we can do the hard work of finding your existing retirement accounts and rolling them over to a Roth IRA for you.
