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Tuesday, June 6, 2023

To convert or not to convert

Possible tax implications of a Roth IRA conversion

Converting to a Roth IRA means you’ll pay tax on the pre-tax amount you convert now instead of during retirement. And that amount could be substantial, so you’ll want to weigh the pros and cons.

First, a Roth conversion is an irrevocable taxable event. In other words, once you convert a specific dollar amount to your Roth IRA, it can’t be undone. It used to be possible to undo a Roth conversion through a process known as recharacterization. However, this option is no longer allowable as of 2018.

When you convert funds to a Roth IRA, this transaction is applicable for the calendar year in which you made the conversion. Unlike IRA contributions, which can generally be made up until the tax filing deadline (usually April 15 of the following year), Roth conversions for a tax year can only be made within the calendar year (meaning you have until market close of the last business day of the year to apply your conversion for a specific tax year).

To touch briefly on traditional IRAs again, these accounts are generally composed of pre-tax assets, but there are situations in which you can make after-tax contributions (or non-deductible contributions) to a traditional IRA. For example, depending on how high your income is, you may not be eligible to contribute directly to a Roth IRA. In situations like this, it’s possible to contribute an after-tax amount to a traditional IRA before converting these funds into a Roth IRA. You may hear this referred to as a “backdoor Roth conversion,” or a “backdoor conversion.” However, there are some technicalities and considerations to bear in mind.

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