In an earlier article on Roth conversions, an advisor wrote: “For many people, a peak time for Roth conversions occurs in the years after retirement, but before Social Security and RMDs kick in. These may be years with relatively low incomes, when initiating a conversion can yield a triple benefit. Those benefits include: lower tax bills, lower RMDs, and future tax-free growth.”
My question is based on what I thought were the rules for Roth contributions, namely that you must have earned income to contribute. How can a retiree put money into a Roth IRA without having any income?
– Marking
That’s a great question, and I get a variation on it often. Unfortunately, there is a lot of nuance in the rules surrounding Roth IRAs. The recent column on the five-year rules also emphasizes this point.
This can make tracking them more complicated and confusing than you might think. The answer to your specific question simply lies in understanding some subtle differences in terminology. Although you need earned income to contribute directly to a Roth IRA, earned income is not required to convert a pre-tax account to a Roth IRA. (If you have similar questions about retirement planning, consider working with a financial advisor.)
A retiree is looking at his retirement accounts and considering a Roth conversion.
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To be clear, your understanding of the Roth contribution rules is spot on. Contributions must come from earned income. Therefore, a retiree who only receives Social Security, pensions, annuity payments, interest, or benefits from retirement plans cannot contribute to a Roth IRA (or a traditional deferred IRA).
But Roth conversions and Roth contributions are not the same.
When you make a Roth contribution, you take money that has already been taxed and send it to a Roth account. There, it will grow tax-free and not be subject to required minimum distributions (RMDs), which begin at age 73 (age 75 for people who reach age 74 after December 31, 2032). A Roth contribution can be made with money you receive from a paycheck or with money in your checking account. The key is that you need income to contribute to a Roth IRA.
A conversion moves money already in a tax-deferred account into a Roth account. The “conversion” occurs because you pay income taxes on the money when you move it into a Roth account.
To make a conversion, you must first have money in a tax-deferred retirement account of some type, like a traditional IRA or 401(k), for example.
Basically, the source of a Roth contribution is earned income. The source of a Roth conversion is a tax-deferred retirement account. (Roth conversions are just one type of tax planning strategy a financial advisor can help you with.)
Although Roth contributions are limited in some ways, there are no restrictions whatsoever on Roth conversions.
For tax year 2024, the Roth IRA contribution limit is $7,000 for those under age 50 and $8,000 for those age 50 and older. However, there is no limit to the amount of money you can convert.
Also take the income limits into account. If your earned income is too high, you won’t be able to contribute to a Roth IRA at all. In 2024, that limit will be $161,000 for single tax filers and $240,000 if you are married and filing a tax return jointly.
While not everyone can contribute directly to a Roth IRA, there are no income restrictions on Roth conversions. Bill Gates could do a Roth conversion if he wanted to. (But if you need extra help navigating the rules surrounding Roth accounts, consider working with a financial advisor.)
Different rules apply to Roth IRAs and Roth 401(k)s, including income and contribution limits.
A related issue that is often the source of confusion is the treatment of Roth accounts within workplace retirement plans.)
Retirement savers often find that the same income restrictions that prevent them from contributing to a Roth IRA also prevent them from contributing to a Roth 401(b) or Roth 403(b). However, that is not true. The Roth IRA income limits do not apply to designated Roth accounts within workplace retirement plans.
As a result, an individual earning more than $161,000 in 2024 could contribute up to $23,000 to a Roth 401(k), if their employer offers this account option. (If you need advice on how to divide your retirement savings contributions between pre-tax and Roth accounts, consider talking to a fiduciary financial advisor about this.)
Roth contributions and Roth conversions are not the same, and they are not governed by the same rules. Any amount you convert will be included in your taxable income in the year of the conversion, but qualified withdrawals will be tax-free in the future. Roth conversions can be part of an effective tax planning strategy, but you shouldn’t do them without careful analysis.
Converting a large retirement savings balance into a Roth IRA all at once can have serious tax consequences. Therefore, you may want to consider a more gradual approach, converting your pre-tax savings into a Roth account over the course of several years. This way you can spread the tax burden more evenly and possibly avoid ending up in a higher tax bracket.
A financial advisor may be able to help you plan your Roth conversions. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Keep an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and provides marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
Brandon Renfro, CFP®, is a financial planning columnist at SmartAsset, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column. Some reader-submitted questions have been edited for clarity or brevity.
Please note that Brandon is not a participant in the SmartAsset AMP platform, is not an employee of SmartAsset, and has received compensation for this article.
