Traditional to Roth IRA Conversion at Vanguard

So, you’ve done your research, read the articles, crunched the numbers, and you want to convert your Traditional IRA held at Vanguard into a Roth IRA. But, how do you actually do it at Vanguard.com? There is no explicit “Convert” button or link to run this conversion. After some fumbling around, I managed to figure it out. But why not just share it here in mind-numbing detail and hopefully save folks some time.

You’ll need to have both a Traditional and Roth IRA set up at Vanguard first (mutual fund only). If you don’t have the Roth yet, click on the “Open an Account” link on the black bar on the top of every page and open an account first. Be sure to indicate that the funds you’ll use to open the new account are “At Vanguard”.

After you already have both a Vanguard Traditional IRA and a Vanguard Roth IRA:

  1. Log in to your account online. Click on “My Portfolio” so that you can view all your accounts.
  2. Under your Traditional IRA section, click on “Buy & Sell”.
  3. Next, click on “Exchange” on any of your funds.
  4. Now, you can choose to Exchange from all your Traditional IRA funds, to funds in your Roth IRA. You may need to add a new fund.
  5. For the exchange amount, if you are doing a complete conversion, chose All. You may be asked to verify and accept any redemption fees.
  6. You’ll also need to choose your tax withholding options. In order to maximize my balances in these tax-deferred accounts, I chose not to withhold and to pay the taxes separately myself later from a taxable account. Also, I can spread the taxes due for a 2010 conversion over two years.
  7. At the end of the next available business day, your mutual funds will be exchanged into your Roth at their net asset values. Your Traditional IRA will still show up with zero balances, which you can hide from displaying.
  8. Your conversion is complete! Keep your transaction confirmations for tax time.

Keep on reading below for some of the warnings and notifications that you’ll encounter during the conversion process.

A conversion is a taxable event. Generally, you’ll owe taxes on the amount you convert from your traditional, SEP-, or rollover IRA into a Roth IRA.

When you convert to a Roth IRA, you may elect to withhold Federal and certain state taxes. You can get the most benefit from the conversion if you don’t have taxes withheld and instead pay taxes from a separate nonretirement account. Keep in mind that the money withheld for taxes isn’t part of the conversion, and, if you’re under age 59½, you may have to pay a 10% federal penalty tax on it. You also can’t “recharacterize”, or restore to a traditional IRA, the amount you withhold. If you choose not to withhold, you may need to make estimated tax payments to avoid an underpayment penalty.

We encourage you to consult a tax advisor about your individual situation. For 2010 conversions only, you have the option of postponing the tax due and paying it off over two years. If you choose this option, taxable income from the conversion gets split evenly between 2011 and 2012. Alternatively, you can choose to pay all the conversion income in 2010.

Moving money out of a retirement account is a distribution, and all or a portion of your distribution may be subject to federal or state tax. You can elect to have either no federal income taxes withheld from your Vanguard IRA® distribution or a percentage between 10 and 100. If you don’t elect to have income taxes withheld from your IRA distribution, you’ll remain liable for income taxes. Tax penalties may also apply if your estimated income tax payments or income tax withholdings are insufficient under federal or state rules.

Comments

  1. Man, I wish I had that list when I tired to do mine.

    Took me about an hour.

    This should be quite helpful to anyonel ooking to make the switch

  2. I have some amount in a rollover-IRA account transferred from my previous employers 401k account. I would like to convert the amount in rollover-IRA to Roth IRA? Any calculators I can find online that will give me an estimate tax liability? Is there a penalty (10%) I need to pay for this conversion? Do I need to make this tax payments right away or while filing my taxes next April? Please advise.

  3. Do you have some examples of when it is a good idea to roll over you IRA into a ROTH IRA?

  4. Can you make multiple conversions to roth in 2010 and choose a different tax year for each conversion? For eg., i’d like to convert half of my IRA and choose to pay taxes on it in 2010. Then I’d like to convert the remaining half of my IRA, and this time choose to have it taxed in 2011 and 2012. Is this something that can be done?

  5. MakingItWorkNJ says:

    @Lone, there is no 10% penalty for doing a conversion from a tax-deferred account (Rollover IRA, old 401k, etc.) to a Roth. What will happen is whatever amount you convert will add to your AGI. For example, if your gross is $35000 after your deductions or whatever and you convert a $5000 to a Roth, now you have a $40000 amount that you have to pay taxes on.

    I did a Roth conversion in 2007 because I was getting the Bush Homebuyer Credit of $7500 (which gets to be paid back starting 2011….grrrr!!). I used part of the proceeds to offset any taxes I had to pay from the conversion.

    For those who want more information, and a calculator, go here:

    http://www.smartmoney.com/personal-finance/retirement/roth-iras-to-convert-or-not-7965/

  6. Vanguard actually has howto guide for Roth conversion:

    https://personal.vanguard.com/us/insights/taxcenter/tips-rothira-conversion

    (I did a search on “roth conversion” at VG homepage and found it :)

  7. I am a self employed commissioned sales person and pay estimated taxes on the following schedule

    Q1- April 15,Q2-june 15, Q3- Sep 15, Q4-Jan 15- (Fourl equal estimated payments totaling 100% of previous years income)

    My sales/income is down this year 2010 – So I am thinking that now might be a good time to convert a traditional IRA to a Roth. I plan to pay all taxes due in one year (2011).

    When would be the most tax advantageous time to convert in 2010.

    I am thinking that if I complete the conversion in December 2010, that any excess taxes due above my estimated taxes due could simply be added to my Jan 15 payment and not trigger any late or underpayment penalties because the actual conversion took place at the end of the year. However, I am concerned that the month of the conversion has little meaning to the IRS since I am reporting as annualized estimates because the nature of my income – Commissioned sales – fluctuates so much, my estimates are not calculated every quarter on actual, but calculated on 100% of last year divide by four equal payments.

    So is my thinking of converting from Traditional to Roth in December going to make a difference to avoid underpayment or am I just another casualty of the IRS Self-employed TAX laws that penalizes the self-employed for not hiring a tax specialist every quarter to provide actual.

  8. There is the 10% penalty if you convert from a traditional to a Roth IRA before 2010 and if you’re 59 and 1/2 years or younger. Here is an example that could guide you:

    Jane, who is younger than age 59 1/2, has $50,000 in a previously untaxed traditional IRA. She wants to transfer that IRA to a Roth IRA. Her return in either type of IRA will be 9% per year. Jane cannot afford to pay the income taxes due on the conversion, so she will keep enough money from the rollover to pay all taxes due. She wants to know if the conversion will result in more income for her in retirement. She assumes her marginal income tax bracket will remain unchanged.
    Source: http://www.definerothira.com

    In this situation, first we must determine how much Jane must withdraw from the traditional IRA to pay her taxes and the 10% penalty that will be due on that withdrawal because she is younger than age 59 1/2. This can be done by using the formula W = T + 0.1W in which W is the total withdrawal and T is the total amount of taxes due on the value of the converted IRA. The formula can be reduced to 0.9W = T.

    If Jane is in the 15% marginal bracket and if her IRA is worth $50,000, then on conversion she will owe $7,500 in ordinary income taxes ($50,000 times 0.15). That means:

    0.9W = T
    0.9W = $7,500
    W = $7,500 / 0.9 = $8,333

    Jane can then withdraw $8,333 from her traditional IRA, convert the remainder ($41,677) to the Roth IRA, and have enough to pay her income taxes of $7,500 plus her $833 early withdrawal penalty. The $833 is 10% of the total amount withdrawn from the converted IRA.

    After-tax comparisons of the Roth IRA to the traditional IRA for each marginal tax rate are shown in the table below. In every case, the Roth IRA fails to match the after-tax results of the unconverted traditional IRA. This failure is due to the lost investment opportunity on the money she withdrew from the converted IRA to pay her taxes and penalty on the conversion.

  9. There is a lot of interest right now in converting traditional IRA’s to Roth IRA’s. In addition, the article mentions this and this is discussed a bit in some of the answers, but be mindful that converting a traditional IRA to a Roth IRA is a taxable event. You will need to pay taxes in the year of your conversion based on the capital gains in your account and if your traditional IRA was previously the result of a 401k you had from an employer, you will have additional taxes to pay on those securities as well. With many people now unemployed or at reduced income levels, paying extra taxes now may not be something you want to do. However, you may also be in a lower tax bracket as a result, so there is an argument for a conversion now, if you can afford it….just make sure to run the numbers or talk to your tax preparer for more advice before you convert.

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