Can I Make 401K or IRA to Roth IRA Conversions? What Are The New Rules and Income Limits

[2013 Update] With a deal to avert the fiscal cliff reached and legislated under the American Taxpayer Relief Act (ATRA) of 2012, a couple of significant employer sponsored retirement plan features have reappeared with some modifications. This includes the Roth 401(k) conversion and Charitable IRA contributions. You can read more about these updated provisions in this article.

Short answer: Yes. But you need to be aware of a couple of rules that changed from 2010. Prior to 2010, only taxpayers with Modified Adjusted Gross Incomes (MAGI) of less than $100,000 in the year of conversion were allowed to convert from a 401K or traditional IRA plan to a Roth IRA. This meant that many “higher-income” individuals that did not qualify for the conversion ended up investing in employer sponsored 401k and Traditional IRA plans. With a Traditional IRA you receive a tax break today, but pay income taxes in retirement. This is opposite of what happens with a Roth IRA where you pay taxes on contributions, but none when you withdraw the funds at retirement.

However new tax laws in 2010 changed the conversion limit, so that even those making more than $100,000 a year in adjusted income were allowed to convert to Roth IRA accounts from Traditional IRAs or 401K plans. They would off course have to pay the applicable income taxes on the conversion. But the revised 2010 tax laws allowed you to spread the tax burden of the conversion over two years. So for example if you conversion tax liability was $50,000 you could have spread the tax liability by adding $25,000 to your 2011 income and $25,000 to your 2012 taxable income. This helped people plan a tax strategy that would minimize their taxes due on the conversion.

Going forward from 2012, the $100,000 income cap on the IRA to Roth IRA conversion was permanently lifted. However the 2 year conversion tax burden disbursement rule is no longer available and applicable taxes must be paid on the same year’s income taxes. So if you convert to an IRA this year and your tax liability is $40,000, you would have to add this entire amount to your taxable income when you file your taxes in 2013.

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You are also able to convert amounts from either a traditional, SEP, or SIMPLE IRA into a Roth IRA.

So in summary, anyone can convert a 401k or a Traditional IRA to a Roth IRA regardless of income. However the ability to spread the tax burden (when converting to a Roth IRA, will are longer be available past 2012. Yet, the Roth IRA conversion can still make a lot of sense for people from a tax management strategy. For example if you feel that your tax rate in retirement will be higher than your current tax rate, the conversion today could make a lot of sense. This is assuming that you can manage the conversion tax burden. There is also no 10% early withdrawal penalty if the funds move from the Traditional IRA to the Roth IRA within in a 60 day window.

Outside of Roth IRA conversions, the following tables summarizes the income limits that apply to regular Roth IRA contributions in 2012 (vs 2011)

2012 Roth IRA Contribution Limits and Income Ranges

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1 thought on “Can I Make 401K or IRA to Roth IRA Conversions? What Are The New Rules and Income Limits”

  1. What are the rules about rollover of aftertax 401K funds to a Roth IRA. There seems to be a range of answers. Is prorata treatment required?


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