Should You Convert Your 401(k) to a Roth IRA

A Roth conversion is the only move in personal finance where you volunteer to hand the IRS a five-figure check.

People do it anyway, because the pitch is irresistible: pay tax once, never again.

The pitch is also incomplete. The tax bill is certain, immediate and permanent — since 2018 you can't undo a conversion. The benefit is a projection about a tax code that doesn't exist yet.

That doesn't make conversions bad. It makes them a price question, not a religion:

Let's price it properly. 👇

Moving a traditional 401(k) to a traditional IRA is a rollover. No tax.

Moving that same pre-tax money to a Roth IRA is a conversion. The untaxed amount lands on your tax return as ordinary income this year.

So a "$100,000 conversion" isn't a transfer. It's a $100,000 spike in ordinary income, stacked on top of everything else you earned.

Also worth killing a myth right now: the Roth IRA income limits do not apply to conversions. Those limits govern annual contributions. A $400,000 earner who can't fund a Roth IRA directly can still convert. Different transaction, different rulebook.

If your tax rate is the same now and later, a conversion changes nothing. Zero. The math is a tie.

The entire value comes from the rate spread. Convert $100,000 at 12% instead of paying 24% later, and you've saved $12,000 — and then that saving compounds tax-free.

Run it backwards and you've lit money on fire.

And here's the comparison most people botch: you deduct at your marginal rate, but you withdraw at your effective rate — refilling the standard deduction (0%), then 10%, then 12%. A retiree can deduct at 24% and withdraw at an effective 14%.

Which means converting to escape a tax rate you were never actually going to pay is the single most common Roth conversion error.

Convert $100,000, owe $24,000. Two ways to pay:

Same conversion, $93,000 difference. Paying from outside money is effectively a bonus Roth contribution that dodges every contribution limit.

If you can't pay the tax from outside cash, that's not a detail to work around. That's usually the answer: don't convert yet.

This is where DIY conversions go wrong. Income doesn't just raise your tax — it trips wires.

1. IRMAA, with a two-year delay. Medicare surcharges are set from your return two years earlier, and they're cliffs, not ramps. Convert at 63, pay a bigger Medicare premium at 65. One dollar over a threshold moves you an entire tier for a full year. (A one-time spike from a genuine life-changing event can sometimes be appealed with Form SSA-44 — but a voluntary conversion isn't one of those events.)

2. ACA subsidies, if you're under 65. Marketplace premiums are income-tested. A conversion can cut your lifetime tax bill and blow up this year's health insurance in the same stroke. For an early retiree, this is often the binding constraint.

3. The Social Security tax torpedo. Up to 85% of your benefit becomes taxable based on combined income. A conversion can drag your benefit into the tax net, so your true marginal rate on conversion dollars runs well above your stated bracket.

4. The 3.8% NIIT, by the side door. Conversions themselves aren't net investment income. But they raise MAGI — which can push your other investment income over the threshold and trigger the surtax on that.

5. Estimated-tax penalties. A big conversion creates tax due now, not next April. Miss safe harbor and you owe penalties. A useful trick: tax withheld is treated as paid evenly across the year, while quarterly estimates are dated — which is why a late-year conversion is often paired with increased withholding elsewhere.

The prime real estate is the stretch between your last paycheck and your first RMD.

Salary: gone. Social Security: maybe delayed. RMDs: not yet.

Retire at 62, claim Social Security at 70, and that's eight years where you personally decide how much taxable income exists.

Why it matters: RMDs generally start at 73 (75 for those turning 74 after 2032). Leave $1.2M alone from 60 to 73 at 7% and it becomes roughly $2.9M — producing a first RMD near $109,000 whether you want it or not, on top of Social Security, at whatever bracket that creates.

Conversions in the gap years shrink that future forced income. Roth IRAs have no lifetime RMDs for the original owner.

One rule people learn the hard way: once you're subject to RMDs, the RMD must come out first and cannot itself be converted. Which is exactly why this work belongs in your 60s, not your 70s.

Nobody good converts "the account." They convert up to a line.

The method:

A retired couple with $750,000 traditional and $40,000 of income might convert $45,000–$60,000 a year for a decade. Unremarkable annually. Transformative cumulatively — and it never once shoves them into a top bracket.

Bonus move: convert in kind after a market drop. Transfer the shares themselves, not cash. You pay tax on the depressed value, and the rebound happens inside the Roth, tax-free. A 20% market decline is effectively a 20%-off coupon on conversion tax.

Before 2018 you could "recharacterize" — convert, watch the market, unwind it if it went badly. The Tax Cuts and Jobs Act killed that for conversions.

So if you convert $200,000 and the market falls 25%, you paid tax on $200,000 and own $150,000. The IRS does not issue refunds for bad timing.

That asymmetry is the strongest argument for converting in annual slices rather than one heroic transaction.

There are two separate five-year rules and confusing them is expensive:

Having held a Roth for a decade does not make this year's conversion instantly accessible. This is the entire mechanic behind the Roth conversion ladder early retirees use: convert a year's spending annually, wait five years, then withdraw each tranche on schedule.

Check the Rule of 55 first. If you separate from your employer during or after the year you turn 55, distributions from that plan escape the 10% early-withdrawal tax. Roll it to an IRA and that exception evaporates. Retiring at 56 and reflexively rolling everything out can lock your bridge money away until 59½.

Know exactly which dollars you're moving. A single 401(k) can contain pre-tax deferrals, employer match, designated Roth money and after-tax non-Roth contributions — four different tax treatments in one account. After-tax dollars in particular can often move to a Roth IRA with little or no tax. Get the breakdown from your administrator in writing before initiating anything.

Use a direct rollover. Have the plan send money trustee-to-trustee. Take the check yourself and 20% mandatory withholding applies — then you must replace that 20% from your own pocket within 60 days or it becomes a taxable distribution, plus a 10% penalty under 59½.

Watch the pro-rata trap. Rolling a big pre-tax 401(k) into a traditional IRA poisons future backdoor Roth contributions, because the pro-rata rule taxes them against all your pre-tax IRA balances. If you use the backdoor, leaving money in the 401(k) is a feature.

A traditional 401(k) isn't broken because it's taxable later. A Roth IRA isn't automatically superior because it's tax-free. They're two tax systems, and a conversion is a toll booth between them.

You want to drive through when the toll is cheap.

Almost nobody should convert everything. Almost everybody nearing retirement with a large traditional balance should be converting something, in measured annual amounts, in the years their income is lowest.

The best conversion isn't the biggest one. It's the boring one you make every December, for the right amount, at a rate you chose on purpose.

See you next issue. 🪙

Penny Brief is for informational and educational purposes only and is not individualized tax, legal or investment advice. Rules referenced (taxation of conversions, 20% mandatory withholding on eligible rollover distributions paid to you, the 10% additional tax before 59½, the separation-from-service exception at 55, RMD ages 73/75, the elimination of recharacterization for conversions after 2017, Roth five-year rules, QCDs from 70½, the SECURE Act 10-year inherited rule, IRMAA's two-year lookback, the 85% Social Security inclusion cap and the 3.8% NIIT) reflect current federal guidance and can change; plan documents may be more restrictive. All figures are hypothetical illustrations assuming a constant 7% return, and ignore state taxes and individual circumstances. Model your own numbers with a qualified tax professional before converting — conversions cannot be undone.

Sources: IRS (rollovers to Roth IRAs, Roth conversion taxation and five-year rules, RMDs, exceptions to the tax on early distributions, QCDs, Net Investment Income Tax, taxation of Social Security benefits); Tax Cuts and Jobs Act (recharacterization repeal); SECURE Act and SECURE 2.0; CMS and SSA (Medicare IRMAA, Form SSA-44).