Roth IRAs offer great benefits you don’t get with other retirement plans. The problem is some people aren’t eligible to contribute to a Roth IRA due to income limits. The good news is you may be able to perform a conversion from your pre-tax retirement plan to take advantage of the benefits post-tax Roth accounts provide. But you must do so before the deadline for Roth conversion passes.
Deadline for Roth IRA Conversions
The deadline to perform Roth conversions is December 31st of the tax-reporting year. So, if you want to convert funds from a traditional IRA to a Roth to count towards your 2023 taxes you must do so by December 31, 2023.
Here’s why you might consider making this move.
If you are ineligible to contribute to a Roth account because of the Roth income limits, you can use what is commonly called the backdoor Roth IRA strategy. This allows you to convert funds from pre-tax IRAs (traditional, SEP, and SIMPLE plans) and 401(k)s into a Roth IRA—hence the more technical term as a Roth conversion.
Converting funds from a pre-tax plan like a traditional IRA into the post-tax Roth IRA may be a good move for you—but it may not be, either. It’s important you understand the tax implications a conversion triggers as well as the benefits.
To explain further, we’ll use the example of converting funds from a traditional IRA.
Tax Benefits of a Roth IRA vs a Traditional IRA
Traditional IRA contributions are made with pre-tax dollars. This allows most eligible taxpayers to take yearly tax deductions on their contributions. Investment income grows tax free in the account. However, your required minimum distributions (RMDs) in retirement are considered ordinary income, and you’ll pay tax on those yearly distributions. The tax benefit you receive is in the here-and-now, before you retire. You’re deferring paying taxes on the contributions of your earned income, as well as on the earnings the account accumulates over time.
Roth IRA contributions are made with post-tax dollars. You are unable to deduct your contributions on your annual income taxes. Just as with a traditional IRA, income grows in the account on a tax-free basis. However, your RMDs of both contributions and investment income is not counted as ordinary income in retirement. This means your RMDs of both contributions and income the account earns on investments are totally tax free. For retirees on a fixed income, this is a big benefit.
Essentially, with a Roth IRA you pay taxes on the seed (contribution), but the plant (or growth) is tax free. If this interests you, consider converting funds before the deadline for Roth conversions ends.
Roth IRA Conversions are Considered Taxable Events
Remember, you’re moving funds from a traditional IRA that allowed pre-tax contributions into a Roth IRA that only accepts post-tax contributions and provides tax-free distributions in retirement. So of course, when you convert those pre-taxed funds to a Roth, the IRS will recoup the taxes you avoided on contributions of earned income to your traditional IRA.
A conversion is taxed to you personally as ordinary income in the year the conversion is made. This is understandable but the caveat is those taxes cannot be paid with those retirement account funds. So, it is important to consult with your CPA to project how much those taxes may be and if it’s a smart move to make—since the conversion taxes must be paid with earned income dollars.
Beat the Deadline for Roth Conversions
Is a Roth IRA better than a traditional IRA?
Will paying taxes now be better than paying them later in retirement?
Should I convert the entire amount in my traditional IRA to a Roth IRA?
These questions have different answers depending on your current income and tax bracket/rate, your expected tax bracket/rate in retirement, and how close to retirement you are. If you decide you want to make this move, make sure you do it before the deadline for Roth conversion passes.
Again, the deadline to convert funds to a Roth IRA is December 31st. Many people don’t see their CPA until January or February and by then, it is too late to perform a Roth conversion for the previous year. You want to take a proactive approach and carefully plan the timing of your conversion to fit within your overall financial and retirement planning.
Additional resources on Roth IRA conversions and Roth accounts: