What is An IRA Conversion Limit and How Will it Impact Your Retirement?

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Many people want to convert one type of retirement account to another type of account. For example, some may want to convert a 401(k) to an IRA or convert a Traditional IRA to a Roth IRA. When you convert one type of account to another, certain rules and limitations apply. Let’s learn more about the IRA conversion limit, and specifically the Traditional to Roth IRA conversion limit. 

What is an IRA conversion?

A conversion is when funds are transferred from one type of retirement account to another type of retirement account. A person may want to convert funds from their 401(k) retirement account into an IRA account or convert funds from a Traditional IRA to a Roth IRA. 

When you want to change where or how your retirement funds are invested, there are three basic ways to do it. Here is a quick overview of the differences:

  1. IRA Transfer. A transfer happens when you move an IRA from one financial institution to another. You can transfer your IRA whenever you like, with no tax penalties, as long as the IRA is of the same type. You can transfer funds from one Traditional IRA to another, one Roth IRA to another, and you can transfer funds from a SEP IRA or SIMPLE IRA (after the two year rule) to a Traditional IRA. Transfers are not reported to the IRS and can happen at any time.  
  2. IRA Rollover. A rollover happens when you are transferring funds from a different type of pre-tax retirement account into a Traditional IRA. The most common rollover is from a 401(k) into a Traditional IRA. You can do a direct rollover, where funds and assets are electronically moved between institutions, or an indirect rollover, where you cash out the retirement account (taking possession of the funds) and put back the money in another IRA. You are only allowed one indirect rollover per 12-month period and must reinvest the money within 60 days to avoid taxes. Rollovers are reported to the IRS, but as long as both accounts are pre-tax and the rollover is completed in time, there is no income tax owed on the transaction. 
  3. IRA Conversion. When you move retirement funds from a pre-tax account like a Traditional IRA to a post-tax account like a Roth IRA, you must complete a Roth IRA conversion. Converting to a Roth IRA is a taxable event, and money withdrawn from a Traditional IRA will be taxed as income, even if you reinvest it in a Roth IRA. There may be a Traditional IRA to Roth IRA conversion limit that applies to this transaction. 

What is the IRA conversion limit? 

There is no limit to the amount of money you can convert from a Traditional to a Roth IRA. There is also no IRA to Roth IRA conversion limit for the frequency of transactions. In fact, many people use the fact that there is no IRA conversion limit, and that funds can be converted at any time, as a way to exceed Roth IRA income and contribution limits, creating what is known as a “backdoor Roth IRA.

People seeking to use the lack of an IRA conversion limit to create a backdoor Roth IRA should act quickly. The Build Back Better bill as passed by Congress in late 2021 will eliminate this loophole. If the bill passes, people will not be able to use the conversion process to bypass Roth IRA contribution and income limits. 

What are the benefits of a Traditional IRA to Roth IRA conversion limit?

While many people prefer the pre-tax benefits of a Traditional IRA, there are some reasons why a person may want to convert a Traditional to a Roth IRA. Here are the benefits of an IRA to Roth IRA conversion:

  • Tax-free withdrawals. Unlike Traditional IRAs, Roth IRA contributions are already taxed, so withdrawals are tax-free. Some people want to simplify their retirement withdrawals without paying taxes or want to create a Roth IRA for their heirs and beneficiaries to enjoy tax-free. 
  • Avoid mandatory withdrawals. Traditional IRAs have mandatory withdrawals, known as Required Minimum Distributions. Some people want to avoid RMDs, and so would prefer to convert their IRA to a Roth IRA. 
  • Remember that converted funds are still subject to early withdrawal penalties, so converting, rolling over, or transferring IRA funds does not allow you to make early withdrawals. 

Points To Consider When Converting from a Traditional to a Roth IRA 

Converting funds from a Traditional to a Roth IRA is a taxable event. While there is no Traditional IRA to Roth conversion limit, you will have to pay taxes on the converted amount. For this reason, it is important to discuss conversion with your tax advisor. Here are some general guidelines for converting from a Traditional to a Roth IRA:

  • Know your tax bracket. Many people choose to convert only what would keep them within the same tax bracket to avoid having an undue tax burden in the year they make the conversion. 
  • Watch your income. Converting from an IRA to a Roth IRA is best done in a year — or years — when you have low income. If you have been out of work, for example, and have a lower income than most years, you can convert from a Traditional to a Roth IRA with less of a tax impact. 
  • Plan long-term. Converting from a Traditional to a Roth IRA is best done over the course of years, with careful planning, in cooperation with your tax advisor. That way you can minimize the impact on your income taxes, and still enjoy the benefits of a Roth IRA after you retire. 

How can IRAR help? 

If you are interested in transferring or rolling over your retirement funds, IRAR has prepared a free guide to help you. Our transfer and rollover guide answers all the most frequently asked questions and has tips and guidance to help you make the right decision. You can always give us a call if you have additional questions; we are here to help.

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