Do-overs are pretty rare in life, but one place you’ll find them is retirement accounts. If you sign up for a traditional IRA or a 401(k) plan then decide later you wished you’d picked a Roth IRA instead, you can switch it over, and it’s a fairly simple process. The catch? You’ll owe taxes.

While a Roth IRA conversion can be a valuable financial move — offering tax-free withdrawals in retirement —  it’s important to be mindful of the tax implications and plan accordingly, especially if you’re rolling over significant funds from a traditional IRA or 401(k).

What is a Roth IRA?

Before diving into taxes, it’s essential to understand what a Roth individual retirement account is.

A Roth IRA is a type of retirement account that offers unique tax advantages. Unlike a traditional IRA, contributions to a Roth IRA are made with after-tax dollars. That means contributions don’t give you an immediate tax break, but when you withdraw the money – both your contributions and earnings – in retirement, it’s tax-free.

In contrast, traditional IRAs and 401(k)s offer a tax break in the year you contribute — your contributions are tax-deductible — but you pay income tax on the money, both your contributions and any earnings, that you take out during retirement.

You can also withdraw the money you put into a Roth IRA at any time without a penalty, though if you take out the earnings before age 59 ½, you’ll owe income taxes and a 10 percent IRS penalty.

What taxes are due on a Roth IRA conversion?

You’ll owe income tax on the amount you convert from a traditional IRA or 401(k) to a Roth IRA, since you’ve never paid tax on that income. The amount you convert is added to your gross income for that tax year. The higher the conversion amount, the more you’ll owe in taxes. This tax is based on your ordinary income tax rate in the year of the conversion.

So, rolling over a significant amount of money from a traditional retirement account to a Roth IRA could push you into a higher tax bracket, and you’d be forced to pay more on each incremental dollar of converted money.

If you’re converting a large amount of money, spreading your Roth IRA conversions over several years instead of doing it all at once can soften your tax blow. By converting smaller amounts annually, you may stay in a lower tax bracket while avoiding getting hit with a significant one-time tax bill in any given year. Making a conversion during a year when your income is unusually low is another way to save money on taxes.

If you convert a Roth 401(k) into a Roth IRA, you don’t have to worry about taxes because they both have the same after-tax treatment. You’ve already paid taxes on your contributions to a Roth 401(k) once, so you don’t have to pay those taxes again.You can use Bankrate’s Roth IRA conversion calculator to estimate the change in your total net worth at retirement if you convert a traditional IRA to a Roth IRA.

What are the benefits of a Roth IRA conversion?

The biggest advantage of a Roth IRA conversion is the tax treatment. While the conversion incurs taxes at the time of the switch, qualified withdrawals from a Roth IRA after the age of 59 ½ are entirely tax-free. This tax-free status applies to both the initial contributions and any earnings, so long as the Roth IRA has been open for at least five years.

A Roth IRA conversion can be especially beneficial if you expect to be in a higher tax bracket in retirement. By paying taxes on the converted amount at your current — and potentially lower — tax rate, you can secure tax-free withdrawals in retirement when tax rates might be higher.

A Roth IRA conversion can also be beneficial for Individuals who are unable to contribute directly to a Roth IRA due to income limits. (Single filers with incomes over $161,000 and married couples filing jointly with incomes over $240,000 in 2024 can’t contribute to a Roth IRA.) This conversion strategy is known as a backdoor Roth IRA.

Finally, Roth IRAs have no required minimum distributions (RMDs) during the account holder’s lifetime. Traditional IRAs and 401(k)s, on the other hand, mandate minimum withdrawals each year starting at age 73. By converting to a Roth IRA, you can avoid RMDs, giving your money even more time to grow tax-free.

How to do a Roth IRA conversion

Converting a 401(k) or traditional IRA to a Roth IRA is a relatively simple process.

Here’s how to get started:

  1. Open a Roth IRA account: Start by opening a Roth IRA account at a financial institution. If you already have one, you can use it for the conversion.
  2. Contact your plan administrators: Get in touch with the financial institutions where the IRAs are held. Ask them about the requirements for moving your money to the new Roth IRA. If you’re staying with the same institution, the process should be easy.
  3. Submit the necessary paperwork: Figure out the paperwork needed for the conversion and submit it. Clearly state which assets are being moved over. If you manage your own funds, check your investment platform’s site for specific instructions.
  4. Wait for the conversion: Usually within a couple of weeks (or even sooner), the conversion to your Roth IRA will be complete.

You can convert your traditional IRA or 401(k) to a Roth IRA in a couple ways.

  • An indirect rollover: An indirect rollover is where you receive a distribution from the old financial institution and then transfer it yourself to your Roth IRA within 60 days.
  • A trustee-to-trustee rollover: A trustee-to-trustee rollover involves having your traditional IRA provider directly transfer funds to your Roth IRA provider on your behalf.

When filing taxes for the year of the conversion, use Form 8606 to inform the IRS about the rollover.

Bottom line

Any money moved from a traditional retirement account to a Roth IRA is considered ordinary income and will be taxed. Be prepared to pay the tax bill. If it’s a hefty amount, consider spreading the conversion over a few years to lessen the hit at tax time. A financial advisor can guide you through the conversion process, and help you decide if it’s the right move for you.