A Roth account is a retirement account that permits contributions to grow tax-free. Contributions are after-tax (i.e., they are not deductible), and withdrawals are tax-free if you follow the distribution rules. Qualified retirement plans and IRAs can be set up as Roth accounts. The rules governing a Roth rollover into an IRA vary depending on whether the source account is a traditional one or a Roth.
There is no limit on the amount of money you can roll over into a Roth IRA from another retirement account.
Roth Conversion Rules
A Roth rollover is called a conversion if the source is a traditional IRA or traditional qualified retirement account. The rollover money is being “converted” from pre-tax to post-tax during a Roth conversion. Traditional accounts contain pre-tax contributions and earnings that are not taxed until withdrawn. Therefore, when you convert a traditional account to a Roth IRA, you must include the rollover amount in your current taxable income. Certain exceptions might apply, as when the traditional source account happens to contain some post-tax money, not to be confused with a Roth source account that contains only post-tax money. A Roth to Roth rollover is not a conversion and has no tax implications. For instance, you pay no taxes or penalties if you roll a Roth 401(k) into a Roth IRA. While a number of different account types can roll over into a Roth IRA, you cannot roll over money from a Roth IRA to any account other than another Roth IRA.
Rollover from an IRA
You can roll over money from a traditional, SEP or SIMPLE IRA to a Roth IRA, and you can roll over a Roth IRA to another Roth IRA. The SEP or SIMPLE IRAs may be traditional or Roth accounts. If the source account is traditional, the rollover is a conversion and is taxable. You have three different ways to roll over a conversion from an IRA account:
- Rollover: You can take a distribution from a traditional IRA and deposit the money within 60 days into a Roth IRA. If you miss the 60-day deadline, you cannot complete the rollover and will be responsible for any early withdrawal penalty tax that might apply. Generally, withdrawals from a traditional IRA before age 59 1/2 are subject to a 10 percent penalty unless an exception applies.
- Trustee-to-trustee transfer: You can instruct the trustee of your traditional IRA to directly transfer the rollover amount to the trustee of the Roth IRA. In this method, the account owner doesn’t receive the distribution, and there is no 60-day deadline to complete the transfer.
- Same trustee transfer: If the traditional and Roth accounts are maintained by the same trustee, you can request the trustee to transfer the rollover amount. Alternatively, you can ask the trustee to redesignate the traditional IRA as a Roth IRA instead of opening a new Roth IRA account.
If you perform a conversion to a Roth IRA, you might need to increase your withholding or increase your estimated tax payments for the year to account for the tax due on the converted amount. There is no limit on the number of conversions you can perform within the year and no required waiting period between conversions.
Rollover From a Qualified Plan
You can roll an employer qualified plan, whether traditional or Roth, into a Roth IRA. Eligible employer plans include qualified pension, profit-sharing (401(k)), stock bonus, annuity, tax-sheltered annuity (403(b)) and governmental deferred compensation (457) plans. Each of these plans might have specific rollover requirements that must be observed. You have two ways to perform a rollover from a qualified plan to a Roth IRA, such as when you transfer a 401(k) to a Roth IRA:
- Rollover: You can receive a distribution from your employer plan and roll it into a Roth IRA within 60 days. If the source account is a traditional (tax-free) account, the rollover is a conversion and you must include the rollover amount in your current taxable income. If you miss the 60-day deadline, you cannot roll the money into your Roth IRA and may be liable for an early withdrawal penalty. Note that the source account trustee must withhold 20 percent of the rollover amount to pay taxes. If you do not replenish the 20 percent with other funds, your rollover amount will be less than the amount distributed and might be subject to a 10 percent early withdrawal penalty. If you do replenish the 20 percent withholding amount, then the full 100 percent of the distribution will count as a rollover, and you can recover the 20 percent withheld when you next file an annual tax return.
- Direct rollover: The employer plan must allow you to request a direct trustee-to-trustee transfer to your Roth IRA. No withholding will occur, and you are not exposed to the 10 percent early withdrawal penalty. Unless the source account is a Roth, the direct rollover is a conversion and the tax-free amount transferred must be added to your current taxable income.
The Role of Basis
In this context, the basis of an IRA or qualified account is the amount of after-tax contributions to the account. In a Roth IRA, all contributions are included in the basis since they are all after-tax. However, traditional accounts can sometimes have a basis as well. For example, the deductibility of your IRA contribution might be reduced or eliminated if you or your spouse is covered by a qualified plan and your income exceeds certain limits. In 2018, if you are covered by an employer plan and file as a single taxpayer, you can take only a partial deduction on your traditional IRA contributions when your modified adjusted gross income is between $63,001 and $72,999. If your modified adjusted gross income is $73,000 or more, no deduction is available. Different limits apply to joint filers in which you or your spouse is covered by an employer plan. In this case, you can still contribute up to $5,500 for the year ($6,500 if you’ve reached age 50), but it’s not deductible and is included in the account’s basis.
For example, suppose you have a traditional IRA with a $100,000 balance, and you have contributed $10,000 of after-tax money to the account. If you decide to make a direct rollover to a Roth IRA, you would include only $90,000 in your taxable income for the year. The remaining $10,000 is the traditional IRA’s basis upon which you’ve already paid taxes, so you do not include it in your current taxable income. The basis of the Roth IRA after the conversion would be $100,000, consisting to the $10,000 basis on the traditional IRA and the $90,000 basis on the converted amount.
Rollover by a Beneficiary
If you inherit the proceeds from an employer qualified plan or an IRA, the ways you can handle the inheritance depend on the designated beneficiary rules, including whether you are a spouse or non-spouse beneficiary, your age and the ultimate age of the deceased. If you wish to roll over the inheritance into a Roth IRA, you’ll have to pay taxes on the conversion. However, if you inherit a Roth IRA, you can roll it over tax-free to your own Roth IRA, of if you are a spouse, simply take possession of the deceased’s IRA. Beneficiaries must take required minimum distributions from a Roth IRA (this requirement doesn’t apply to the original account holder), and the period over which you can stretch out these distributions depends on the designated beneficiary rules.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.