This article is about converting money from a traditional retirement account to a Roth IRA. Roth IRA conversions can come from a traditional IRA or from your traditional TSP. Be aware that, if you are a current federal employee and are under age 59 ½, you cannot convert money from your TSP to a Roth IRA; you cannot roll it into a traditional IRA either. So, most of this article will focus on IRA to IRA conversions. At present, you are not allowed to convert any part of your traditional TSP balance into the Roth portion of your TSP.
Thing 1) There are no restrictions on converting a traditional IRA to a Roth IRA. There are no income limits that preclude a conversion and you do not have to have earned income to convert. This is different from contributing to an IRA, where there are income limits and the requirement that you have earned income sufficient to make the contribution that apply.
Thing 2) There is no limit on the amount that you can convert. And, the amount converted does not count towards the annual IRA contribution limit ($6,000 in both 2021 and 2022).
Thing 3) Unlike an IRA contribution which can be done up to the tax filing date for the subsequent year (e.g., April 18, 2022 for 2021 IRA contributions), Conversions must be completed by December 31st.
Thing 4) If you’re of the age where you must take required minimum distributions, your RMD must be taken before you can convert any money.
Thing 5) An inherited IRA cannot be converted. You would have to transfer (roll over) the inherited into an IRA in your name before you converted anything.
Thing 6) You will not face a 10% penalty if you convert a traditional IRA to a Roth IRA prior to the age of 59 ½. See “thing 10” on taxes for an exception to this rule.
Thing 7) On the other hand. There’s a penalty if you take converted dollars out of a Roth IRA within five years of converting it – with (of course) an exception. The exception is that if you have held any Roth IRA for at least five years and are at least 59 ½ when you take the converted money out there will be no penalty.
Thing 8) This is related to thing 7, above. When you withdraw from an IRA, the money you take out is viewed as first coming from contributions, then from converted money, and lastly from earnings.
Thing 9) You pay taxes on the money you convert from a traditional IRA to a Roth IRA. The amount of the conversion will be added to your adjusted gross income for federal income tax purposes. You do not have to pay taxes at the time of the conversion but, if you’re making a large conversion, you might want to make an estimated tax payment to avoid any other penalties (e.g., underpayment) at tax time.
Thing 10) It is wise to pay the taxes on the conversion from a source other than the IRA itself. This is especially true if you are under the age of 59 ½. Money from a traditional IRA that is used to pay the taxes on the conversion is not itself converted and therefore will be subject to a 10% early withdrawal penalty (once again, only if you are under 59 ½) in addition to the taxes owed.
Taxes and the rules on IRAs are confusing. Make sure your financial advisor understands tax rules and that your accountant knows about how withdrawals from investments are taxed. If you still “do it yourself” with taxes and use a tax software, make sure that you ask the software to query you about your entries.