Rules for Converting Money From a Traditional IRA to a Roth

I just read your Reducing RMDs article, in which you advised the reader to start converting money from a traditional IRA to a Roth IRA. I thought you had to have earned income to be able to contribute to a Roth IRA, and a pension is not earned income. What are the rules?

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You are correct that you need earned income in order to make new contributions to a Roth IRA. But that prerequisite doesn’t apply to converting money from a traditional IRA to a Roth. You can convert at any time, regardless of your age or income. You must pay taxes on the amount converted (part of it will be tax-free if you have made nondeductible contributions to your traditional IRA), but earnings after the conversion are tax-free rather than simply tax-deferred. Roth IRAs aren’t subject to required minimum distributions, either, and your heirs can inherit the money income-tax-free.

Consider spreading IRA conversions over several years if it helps you stay below the income cutoff for the next tax bracket or to avoid the Medicare high-income surcharge, which boosts Part B and Part D premiums if your adjusted gross income is higher than $85,000 for single filers or $170,000 for those who are married.

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If you are under age 59½, note that each conversion will be subject to a separate five-year holding period: You must wait five years or until you reach age 59½ before you can withdraw the converted amount without a 10% penalty. Once you have had any Roth IRA for five years – whether you started it with a contribution or a conversion -- and you are at least 59½, earnings can be withdrawn tax-free. Converted amounts, as well as contributions to a Roth, can be withdrawn tax-free at any age, even if you are subject to the penalty, and they are considered to be withdrawn before you dip into earnings. See Tax Rules for Roth Withdrawals for more information.

If you change your mind, you have until October 15 of the following year to undo the conversion and shift the money back to a traditional IRA, in a move called “recharacterization.” If you already paid taxes on the conversion, you can file an amended return and get the money back. See Do-Over for a Roth Conversion for more information.

To learn more about the Roth IRA rules, see 10 Things You Must Know About Roth Accounts. Also see Why You Need a Roth IRA and our Roth IRA special report.