Roth conversions and the low income year

How it works

Any amount of a traditional IRA, SEP, SIMPLE, or eligible plan balance can be converted to a Roth IRA, with no income limit and no yearly cap. The converted amount is added to taxable income for that year and taxed at the person's marginal rates, which is why the cost depends on what else was earned. In a year with little other income, a conversion can fill the standard deduction of this year's official standard deduction single (not yet verified here; see the official source below) or this year's official standard deduction married (not yet verified here; see the official source below) and the lowest brackets at a low rate, while the same conversion in a high income year is taxed at the top rate. Conversions are permanent; the law no longer allows them to be undone. Each conversion starts its own five year clock for penalty purposes, and the tax is usually paid from other money so the whole amount reaches the Roth.

What it gives

Tax is paid once, at a rate the person can see in advance, and never again on that money or its growth.

A gap year, early retirement, or a sabbatical turns a low tax rate into a conversion opportunity.

Converted money has no required minimum distributions during the owner's life.

What it costs, or where the catch is

The tax bill is due this year, and paying it from the IRA itself shrinks the amount converted and may add a penalty.

A large conversion can raise Medicare premiums two years later and reduce other income based benefits.

A conversion cannot be reversed if the market falls or the tax bill turns out larger than expected.

A worked example

Mateo retires at 61 with $500,000 in a traditional IRA and lives on cash for a year, so his other income is $4,000 of interest. He converts $40,000. After the standard deduction most of it falls in the 10 and 12 percent brackets, and the federal tax comes to about $3,200, which is 8 percent of the amount. The same $40,000 converted while he was earning $140,000 would have been taxed at 24 percent, about $9,600.

Where it goes wrong

The common miss is converting a round number without running the arithmetic and landing part of it in a higher bracket, or paying the tax from the IRA and triggering a penalty on that withdrawal.

Who confirms it for you

For your own numbers, a CPA or enrolled agent. This page explains how the rule works for people in general; it does not know your situation and does not tell you what to do.

The official source

IRS Publication 590-A, Contributions to Individual Retirement Arrangements. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.