The tax benefits of Roth accounts are clear: Tax-free growth potential and tax-free withdrawals in retirement. 1 If you arent able to contribute to a Roth IRA because of the income limits,2 a Roth conversion of eligible retirement assets is another way to fund a Roth account. 3 But does it make sense if you are retired or plan to retire soon? Maybe. A Roth account, even via a conversion, has the potential to benefit your retirement and legacy planning.
While your situation is unique and should be discussed with a tax professional, here are 7 things to keep in mind when thinking about a conversion.
It’s important to know how different financial decisions affect your Modified Adjusted Gross Income (MAGI) when you’re planning for retirement and doing your taxes. One question that investors and tax experts often have is whether Roth conversions change MAGI. This is an important thing to think about because it can affect many parts of your tax situation, from your tax credits and deductions to your health insurance premiums.
What Exactly is a Roth Conversion?
Before diving into the MAGI implications, let’s quickly review what a Roth conversion is. A Roth conversion involves moving funds from a traditional IRA or 401(k) into a Roth IRA. The key difference between these account types is when you pay taxes
- With traditional IRAs/401(k)s, you get a tax deduction when you contribute, but pay taxes when you withdraw in retirement
- With Roth IRAs, you pay taxes on contributions now, but get tax-free growth and withdrawals in retirement
When you convert you’re essentially choosing to pay taxes now instead of later.
The Short Answer: Yes, Roth Conversions Do Affect MAGI (But With a Twist)
Yes, Roth conversions are included in your Modified Adjusted Gross Income (MAGI) for most tax purposes. When you convert funds from a traditional retirement account to a Roth IRA that converted amount is considered taxable income in the year of conversion, which increases your MAGI.
However—and this is where it gets interesting—Roth conversions are NOT included in MAGI for one specific purpose: determining whether you’re eligible to make direct contributions to a Roth IRA.
The Special Exception: Roth IRA Contribution Eligibility
IRC Section 408A(c)(3)(B)(i) says that Roth conversion amounts are not included in the MAGI calculation when figuring out if you can make annual contributions to a Roth IRA.
This means you could do a large Roth conversion that pushes your income well above the Roth IRA contribution limits, yet still be eligible to make a direct Roth IRA contribution for that same tax year!
A financial expert named David McKnight says on his website, “One question we often get is whether Roth Conversions count toward the Modified Adjusted Gross Income (MAGI) thresholds that phase out Roth contributions.” The short answer is ‘no’. “.
Why This Exception Exists: A Historical Quirk
This exception isn’t a fluke; it comes from the way Roth IRAs were set up in 1997. When Congress set up Roth IRAs (which started in 1998), they put limits on both MAGI and
- The ability to make direct annual Roth contributions
- The ability to convert traditional accounts to Roth accounts
This created a potential circular definition problem. If Roth conversion amounts were included in the MAGI definition used to determine eligibility for Roth conversions, you’d have to test conversions against themselves!
For example, if your AGI was $90,000 before a $40,000 Roth conversion, the conversion itself would push you over the then-$100,000 MAGI limit for conversions, essentially disqualifying itself. To avoid this circular logic, lawmakers excluded Roth conversion amounts from the MAGI definition.
Later, in 2010, Congress removed the income limits on Roth conversions altogether (through the Tax Increase Protection and Reconciliation Act of 2005), but the exclusion of conversion amounts from the MAGI test for Roth contributions remained in the tax code.
MAGI Implications for Other Tax Situations
While Roth conversions don’t count toward MAGI for Roth contribution eligibility, they absolutely do count for other important tax calculations:
1. Net Investment Income Tax (NIIT)
A Roth conversion can push your MAGI above the thresholds for the 3.8% Net Investment Income Tax:
- $250,000 for married filing jointly
- $125,000 for married filing separately
- $200,000 for single filers and heads of household
2. Medicare Premium Surcharges (IRMAA)
Higher MAGI from a Roth conversion might trigger Income-Related Monthly Adjustment Amounts (IRMAA) that increase your Medicare Part B and Part D premiums.
3. Tax Credits and Deductions
Many tax benefits phase out as your MAGI increases, including:
- Child Tax Credit
- American Opportunity Tax Credit
- Student loan interest deduction
- Traditional IRA deduction (if you or your spouse are covered by an employer retirement plan)
Real-World Example: Confusion in Tax Preparation
The distinction between how Roth conversions affect MAGI for different purposes can create confusion even among tax professionals. In a discussion on the Intuit Accountants Community, one tax preparer shared:
“My client received a letter from IRS that his IRA deduction was not allowed and should have been non-deductible. However, according to the Lacerte IRA deduction worksheet, my client’s Roth conversion is not included in modified adjusted gross income and references publication 590.”
After further investigation, they confirmed: “Just got off phone with Lacerte and worksheets are not correct IRS is correct.” This highlights how even tax software can sometimes implement these rules incorrectly.
Strategic Planning Around Roth Conversions and MAGI
Understanding these MAGI implications allows for strategic tax planning:
1. Timing Your Conversions
Consider converting in years when your income is lower to minimize the tax impact. Many retirees do conversions in the early retirement years before Required Minimum Distributions (RMDs) kick in.
2. Multi-Year Conversion Strategy
Instead of converting your entire traditional IRA in one year (which could push you into higher tax brackets), spread the conversion across multiple years to manage your MAGI.
3. Backdoor Roth Strategy
If your income exceeds the Roth contribution limits, you can still use the “backdoor Roth” strategy:
- Contribute to a non-deductible traditional IRA
- Convert those funds to a Roth IRA
- Since the conversion doesn’t count toward the MAGI test for Roth contribution eligibility, this remains a viable strategy
4. Coordinating with Other Tax Events
Plan conversions for years when you have offsetting deductions or lower income from other sources.
Common Questions About Roth Conversions and MAGI
Do IRA distributions count toward MAGI for Roth contribution eligibility?
Yes, unlike Roth conversions, regular distributions from traditional IRAs do count toward your MAGI for determining Roth contribution eligibility.
Can I still make a Roth contribution if I did a large Roth conversion?
Yes! The Roth conversion amount won’t affect your eligibility to make direct Roth contributions (assuming your other income doesn’t exceed the limits).
Are Roth conversions included in AGI?
Yes, Roth conversions are included in your Adjusted Gross Income (AGI) and generally in your MAGI—except for the specific purpose of determining Roth contribution eligibility.
Final Thoughts
The relationship between Roth conversions and MAGI is more complex than it initially appears. While conversions generally increase your MAGI for most tax purposes, they’re excluded when determining if you can make direct Roth IRA contributions.
We find this distinction creates opportunities for strategic tax planning that many investors overlook. By understanding these nuances, you can make more informed decisions about when and how much to convert, potentially saving thousands in taxes over your lifetime.
When considering a Roth conversion, it’s always wise to consult with a qualified tax professional who understands these specific rules. The tax implications can be significant, and what works for one person might not be optimal for another based on their complete financial picture.
Have you done a Roth conversion? Were you aware of how it affected your MAGI for different purposes? Let us know in the comments!
Workplace retirement plan options
There are two different considerations to make when planning the timing and size of a Roth conversion from your workplace retirement plan, as opposed to a conversion from an IRA: company stock held in the plan; and plan rules around the Roth option, if applicable.
If youre retiring and have appreciated company stock in your traditional 401(k) or other qualified workplace savings plan, it may not make sense to convert these assets to a Roth IRA. Special tax rules on net unrealized appreciation (NUA), if you qualify, allow you to take a lump-sum distribution from your plan of the entire account balance and pay income tax (and a 10% penalty, if youre under age 59½) on your cost basis. Then, you can wait to pay taxes on the NUA (the stock’s value going up since you bought it) until you sell the stock. At that time, the NUA would be taxable as long-term capital gains. Unless you bought the stock less than a year ago, this will likely cost you less than having it taxed as regular income, which is what would happen if you converted it from a Roth IRA.
Read Viewpoints on Fidelity.com: Make the most of company stock
If youre still working, you are not typically allowed to do a Roth IRA rollover from your 401(k) or 403(b) unless your plan allows for in-service withdrawals. However, if your plan allows, you may be able to consider one of 2 options: Contribute to your company’s Roth 401(k) if offered by your employer, or do an in-plan conversion to a Roth 401(k).
An in-plan conversion isn’t always possible, and even when it is, a Roth 401(k) doesn’t have all the same benefits as a Roth IRA. If you are unable to convert to a Roth IRA, the Roth 401(K) option may be worth exploring. Many people have made after-tax contributions to their 401(k), which are also known as nonqualified contributions.
On the other hand, 401(k)s may offer benefits that IRAs do not, such as institutional pricing on investment products, greater legal protection under ERISA, and the ability to take loans.
Discuss your situation with a tax and financial professional to help you make a fully informed decision.
If you have children who are currently in—or are close to starting—college, and who are applying for financial aid, a Roth conversion may have an impact. Because the amount converted is treated as income, its included in the needs test on the Free Application for Federal Student Aid (FAFSA) and can potentially raise a parents expected financial contribution (EFC) and reduce aid. If you request it, some universities may adjust their calculation to account for Roth conversion income in their private financial aid formulas, but federal aid formulas do not. So if youre seeking financial aid, especially federal, it may make sense to wait to convert until your children are out of college.
Required minimum distributions (RMDs)
Roth IRAs and employer plans do not have required minimum distributions during the life of the original owner. But traditional IRAs, and, generally, traditional 401(k)s, 403(b)s, and other employer-sponsored retirement savings plans do, starting at age 73.4
Note that as of January 1, 2024, RMDs are no longer required from Roth 401(k)s and other workplace plans while the original account owner is still alive due to a provision of the SECURE Act 2.0.
If you dont need the income from these distributions to meet current retirement expenses, RMDs may feel like a nuisance: They need to be calculated each year, may provide unnecessary taxable income, and, if you miss taking one, can result in stiff penalties.
Converting from eligible accounts to Roth may reduce your RMDs and may also allow you to pass more of your retirement account savings on to your heirs (see No. 4). When considering whether to convert to Roth, however, keep in mind that the potential benefits of doing so are largely reliant on your current tax bracket being lower now than in the future. Otherwise, you may be accelerating tax bills that you could otherwise defer.
Consider this hypothetical example: Mark, 75, had $100,000 in a traditional IRA at the end of last year. His wife, Ann, the sole beneficiary of his IRA, is 6 years younger than he is. Marks RMD for the year would be $4,065.5 If Mark didnt need this money, a Roth conversion of the assets remaining in the traditional IRA could allow him to avoid successively larger RMDs in the years ahead, and provide an opportunity for his money to grow tax-free instead. Of course, Mark would need to factor in the tax payment triggered from a conversion to see if this strategy makes sense for his situation (see #7).