Roth Conversion
Roth Conversion
The process of transferring funds from a Traditional IRA, SEP IRA, SIMPLE IRA, or employer-sponsored retirement plan (401(k), 403(b)) to a Roth IRA, paying ordinary income tax on the converted pre-tax amount in the year of conversion. Since 2010, there are no income limits for conversions, making this strategy available to all taxpayers regardless of income level. Each conversion is subject to a separate 5-year holding period before converted amounts can be withdrawn penalty-free (even if over age 59½). Conversions are irrevocable and cannot be recharacterized.
A 55-year-old executive with $500,000 in a Traditional IRA expects to retire in a lower tax bracket. However, her estate planning attorney recommends a Roth conversion strategy. She converts $50,000 annually over 10 years, paying taxes at her current 32% rate ($16,000 per year). This creates a $500,000 tax-free Roth IRA for her heirs with no RMD requirements during her lifetime, and all future growth is tax-free. The strategy works because she values tax-free inheritance over current tax savings.
Students often confuse Roth conversions with Roth contributions. Conversions have NO income limits (removed in 2010), while direct Roth IRA contributions have MAGI phase-out ranges. Another common error: assuming the 5-year rule for conversions is the same as the 5-year rule for Roth IRA earnings. Each conversion has its own 5-year clock for penalty-free access to converted amounts (separate from the earnings rule). Also frequently missed: conversions were recharacterizable (reversible) until 2018, but are now permanent and irrevocable.
How This Is Tested
- Identifying when Roth conversions are appropriate based on current vs. future tax bracket expectations
- Understanding that conversions have no income limits, unlike direct Roth IRA contributions
- Calculating the tax liability on a Roth conversion based on the converted amount and tax bracket
- Applying the 5-year rule to conversions: each conversion starts its own 5-year clock for penalty-free access
- Recognizing that conversions trigger immediate ordinary income tax but eliminate future RMDs and create tax-free growth
Regulatory Limits
| Description | Limit | Notes |
|---|---|---|
| Income limits for conversions | None (no income restrictions) | Income limits were eliminated in 2010; all taxpayers can convert regardless of MAGI |
| 5-year holding period per conversion | 5 tax years | Each conversion has separate 5-year clock starting January 1 of conversion year; applies to penalty-free access to converted principal |
| Tax treatment of conversion | Ordinary income tax | Converted amount taxed at marginal rate in year of conversion; no 10% penalty on conversion itself |
| Early withdrawal penalty on conversions | 10% penalty | Applies only if converted amount withdrawn before 5-year holding period AND owner under age 59½ |
| Recharacterization (reversal) option | Not permitted | Roth conversions became irrevocable starting 2018 (Tax Cuts and Jobs Act); cannot be reversed |
Example Exam Questions
Test your understanding with these practice questions. Select an answer to see the explanation.
David, age 58, has $400,000 in a Traditional IRA and expects to retire at age 65. He is currently in the 24% tax bracket but expects to be in the 32% bracket in retirement due to pension income and required minimum distributions. He is considering converting $80,000 to a Roth IRA this year. Which statement best describes the suitability of this strategy?
B is correct. The Roth conversion strategy is appropriate for David because he expects to be in a higher tax bracket in retirement (32%) than he is currently (24%). By converting $80,000 now and paying $19,200 in taxes (24% rate), he avoids paying 32% tax on the same amount (plus growth) in retirement. The 8-percentage-point tax savings (32% - 24%) on both the principal and decades of future growth makes this conversion financially beneficial. Additionally, the converted Roth IRA will have no RMDs during his lifetime, giving him more control over retirement distributions.
A is incorrect because retirement withdrawals from Traditional IRAs are NOT tax-free; they are taxed as ordinary income. David will not "avoid all taxes" by waiting; he will pay higher taxes (32%) on larger amounts (original balance plus growth). The question is not whether to pay taxes, but when and at what rate. B is incorrect about avoiding all taxes. C is completely false: there is no age restriction on Roth conversions. Anyone can convert at any age. D is false: there are no dollar limits on Roth conversions. You can convert any amount, regardless of account balance (though large conversions may push you into higher tax brackets).
The Series 65 exam tests your ability to evaluate Roth conversion suitability based on current versus expected future tax rates. This is the primary factor in conversion decisions. Understanding that conversions make sense when current rates are lower than expected future rates is critical for advising clients on tax-efficient retirement strategies. The exam will present scenarios requiring you to weigh immediate tax costs against long-term tax savings.
How is the amount converted from a Traditional IRA to a Roth IRA taxed in the year of conversion?
B is correct. Roth conversions are taxed as ordinary income in the year of conversion, at the taxpayer's marginal tax rate. The entire pre-tax amount converted is added to taxable income for that year. For example, converting $50,000 while in the 24% bracket adds $12,000 in federal income tax liability.
A is incorrect because conversions are not treated as capital gains; they are ordinary income regardless of what assets are held in the IRA. C is incorrect because there is no flat 10% conversion tax. The 10% early withdrawal penalty does NOT apply to the conversion itself (only to early withdrawals of converted amounts within 5 years if under 59½). D is incorrect because taxes are due immediately in the year of conversion, not deferred until later Roth IRA withdrawals. In fact, qualified Roth distributions are tax-free, so if taxes were not paid at conversion, they would never be paid.
The Series 65 exam frequently tests knowledge of how Roth conversions are taxed. Understanding that conversions trigger immediate ordinary income tax (not capital gains, not penalties, not deferred) is fundamental to calculating conversion costs and advising clients. This concept appears in both calculation questions (computing tax liability) and scenario questions (evaluating conversion suitability based on current tax bracket).
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Access Free BetaA client in the 32% federal tax bracket and 5% state tax bracket converts $100,000 from a Traditional IRA to a Roth IRA. Assuming the entire Traditional IRA balance is pre-tax (no basis), what is the total combined federal and state tax liability on this conversion?
B is correct. Calculate the total tax liability:
Federal tax: $100,000 × 32% = $32,000
State tax: $100,000 × 5% = $5,000
Total tax liability: $32,000 + $5,000 = $37,000
The conversion adds $100,000 to taxable income, which is taxed at both federal (32%) and state (5%) marginal rates. Combined effective rate is 37%.
A ($32,000) only includes federal tax and omits the $5,000 state tax liability. C ($42,000) incorrectly adds a 10% penalty, but the 10% early withdrawal penalty does NOT apply to conversions themselves (only to early withdrawals of converted amounts). D ($47,000) incorrectly combines federal, state, and a non-existent penalty.
Conversion tax calculations are frequently tested on the Series 65 exam. You must understand that conversions trigger ordinary income tax at both federal and state levels, but do NOT trigger the 10% early withdrawal penalty. Advisers need to calculate total tax costs (including state taxes) to properly evaluate whether conversions are financially beneficial and whether clients have sufficient liquid assets to pay the tax bill without withdrawing from the IRA itself.
All of the following statements about Roth conversions are accurate EXCEPT
C is correct (the EXCEPT answer). Roth conversions are NO LONGER recharacterizable (reversible). The Tax Cuts and Jobs Act of 2017 eliminated the ability to recharacterize conversions starting in 2018. Once you convert to a Roth IRA, the conversion is permanent and irrevocable. This is a critical change from pre-2018 rules when taxpayers could reverse conversions until the tax filing deadline (including extensions).
A is accurate: Since 2010, income limits for Roth conversions were eliminated. High earners who exceed the Roth IRA contribution income limits can still convert unlimited amounts from Traditional IRAs to Roth IRAs (the "backdoor Roth" strategy). B is accurate: Each conversion has its own 5-year clock starting January 1 of the conversion year. If you convert amounts in 2024, 2025, and 2026, each conversion has a separate 5-year holding period for penalty-free access. D is accurate: Conversions trigger ordinary income tax in the conversion year on the pre-tax amount converted, taxed at marginal rates.
The Series 65 exam tests knowledge of the 2018 rule change eliminating conversion recharacterization. This is a frequent exam topic because many older study materials still reference the ability to reverse conversions. Understanding that conversions are now permanent and irrevocable is critical for advising clients, who must be certain about their decision before converting. The exam often uses EXCEPT questions to test whether you know current rules versus outdated provisions.
A 62-year-old client with a MAGI of $300,000 is considering converting $150,000 from her Traditional IRA to a Roth IRA in 2026. She is in the 35% tax bracket. Which of the following statements about this potential conversion are accurate?
1. She is ineligible to convert because her MAGI exceeds the Roth IRA income limits
2. The conversion will add $150,000 to her taxable income, resulting in approximately $52,500 in additional federal tax
3. If she converts in 2026 and withdraws the converted amount in 2029 (age 65), she will owe a 10% penalty on the withdrawal
4. After conversion, the $150,000 (plus growth) will never be subject to required minimum distributions during her lifetime
A is correct. Only statements 2 and 4 are accurate.
Statement 1 is FALSE: There are NO income limits for Roth conversions. The income limits ($242,000-$252,000 MAGI for married filing jointly in 2026) apply only to direct Roth IRA contributions, not conversions. Since 2010, anyone can convert regardless of income level. This is precisely why high earners use the "backdoor Roth" strategy: contribute to a non-deductible Traditional IRA, then immediately convert to Roth IRA, bypassing contribution income limits.
Statement 2 is TRUE: The $150,000 conversion adds to her taxable income and is taxed at her 35% marginal rate: $150,000 × 35% = $52,500 in federal tax (plus state taxes if applicable). This tax is due in the year of conversion (2026).
Statement 3 is FALSE: The 10% early withdrawal penalty would NOT apply to this scenario. While each conversion is subject to a 5-year holding period, the penalty only applies if TWO conditions are met: (1) withdrawal before the 5-year period, AND (2) the owner is under age 59½. Here, she converts in 2026 and withdraws in 2029 (only 3 years, violating the 5-year rule), BUT she is age 65 at withdrawal (over 59½), so the age exception applies and no penalty is owed. The 5-year rule for conversions only matters if you are under 59½.
Statement 4 is TRUE: Roth IRAs have no required minimum distributions during the owner's lifetime. After conversion, the funds will grow tax-free and never be subject to RMDs while she is alive, unlike her Traditional IRA which would require RMDs starting at age 73.
The Series 65 exam tests comprehensive understanding of Roth conversion rules in integrated scenarios. You must evaluate multiple factors: income eligibility (no limits for conversions vs. contribution limits), tax calculations, the 5-year rule for conversions (and its interaction with age 59½), and RMD treatment. The 5-year conversion rule is particularly tricky: it only triggers the 10% penalty if BOTH conditions are met (early withdrawal AND under 59½). Many candidates incorrectly apply the penalty to anyone withdrawing converted amounts before 5 years, forgetting the age 59½ exception.
💡 Memory Aid
Think of Roth Conversion as "Pay the Toll Now, Free Highway Forever": You pay the tax toll NOW (ordinary income tax on converted amount), but then drive the tax-free highway FOREVER (no taxes on growth, no RMDs). Remember "2010 = Income Limits Gone" for conversions (not contributions). For the 5-year rule: "Five Years per Conversion, 59½ Saves You" (each conversion has its own 5-year clock, but if you are over 59½, no penalty even if you withdraw early). "No Take-Backs Since 2018" (conversions are irrevocable, cannot recharacterize).
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