Traditional IRA to Roth IRA Conversion Revisited

Almost exactly a year ago, I pondered whether to convert my Traditional IRA into a Roth IRA. I ended up not doing it right away after realizing that I might hit the ceiling that limits conversions to those with a modified adjusted gross income (MAGI) of $100,000 or less. The same ceiling applies for both a single person and a married couple’s combined income! And if you go the married filing separately route, you can’t convert your IRA at all. I never understand these marriage penalties.

Of course, then I quit my job in July so I should have just gone ahead and converted it. But then I thought, maybe we might even end up in the 15% tax bracket for 2006! That would really save on taxes. But it doesn’t look like it (which is a good thing of course.) So we’ll most likely convert this year. Some additional things I want to take into account are:

1) I recently rolled over my 401k into a Rollover IRA. So that’s a total of $23,600 of pre-tax money I can convert to a Roth. That would also leave a pretty big tax bill upon conversion. I’ll see if I can put paying that off until the end of the year.

2) I want to do a SEP IRA for my 2005 self-employment income, which I haven’t set up yet. If I set it up in 2006, can I go ahead and just convert this to a Roth IRA the next day? I haven’t read anything specific saying that I can or can’t do this. If this is allowed, why can’t people just open up a Roth SEP IRA directly?

3) Finally, all those Should-I-Convert calculators and scenarios assume that the tax rates will stay the same for the next 40 years, and that Roth IRA distributions will remain untaxed. But how sure are we of that? Maybe a 50/50 mix of pre-tax and post-tax money would be better.

For those of you that are also pondering converting their Traditional IRAs, this Fairmark Guide to the Conversion Decision is the best online resource I have found. It’s long, but very thorough.


  1. I’m currently considering and worried about hitting the AGI limit. Anyone know what happens if you hit that limit but have already converted? And the tax question is a great one. What if we go to a VAT or Ntl sales tax system; wouldn’t that mean that none of this retirement stuff would be taxed on withdrawal?

  2. This is interesting. I’m in the same boat as you – quit my job recently, went back to school and my wife is working. I have a $26,000 401(k) I’d like to roll into a Roth. So – I have a question about my undestanding of the income limits. If my MAGI is less than 100k, I can do a conversion of the entire thing? Also – from what I read on that Fairmark website – the MAGI does not include the amount rolled over? For instance, our MAGI should be about 90k for 2006. Can I roll the entire 26k over this year, even though my AGI would rise above $100,000?

  3. The amounts being converted are not included for determining MAGI. A good resource for Roth IRA conversions is Ed Slotts book The Retirement Savings Time Bomb.
    One thought I had on managing the 100,000 limit is if your income is primarily self employment then you could form a C corp and divvy out your salary in such a way that one year you had a lower income to be able to make the conversion if you had past 401k plans or other retirement savings you wished to convert.

  4. i think this year is a good year for the rollover since ur expected income will be lowest in the near future.

    since ur tax bracket is low this year, u should contribute to roth 1st then sep.

    for me, i fully contribute to roth and the remaining goes to 401k. roth distribution should be tax free, else millions of people will sue the government.

  5. This isn’t quite on topic but I think it’s pretty unfair to have a limit of 100k given the different cost of labor in different parts of the country. My fiance and I will hit that very easily where we live…not because we’re highly paid execs, but because that’s just a fact of living in an expensive area.

  6. If you find out about SEP conversion, let me know. I’d like to do that, too, but I haven’t found details yet.


  7. Matt – If that happens you can ‘recharacterize’ your Roth back into a Traditional. Just be sure to do it so you don’t pay tax penalties. No idea about the VAT stuff. =/

    Adam, yes you are eligible for conversion, but you’ll be paying taxes on the whole 90+26 = 116k. Since you are married, this won’t push you into a new tax bracket just yet. Careful though, the 28% tax bracket looms for married couples at MAGI of $123,700.

    Wes – I know that SEP IRAs are eligible for conversion, but for some reason I thought I heard you had to wait a year. I can’t find anything about it again, so I may have been dreaming about IRAs again in my sleep…

  8. Anonymous says:

    Do you have to file a Schedule C to open a SEP IRA?

  9. The answer to #2… The SEP IRA conversion is yes. You can make your 2005 SEP IRA contribution up until April 17th 2006. Then you can immediately convert the amount to your ROTH IRA. This conversion will be considered having taken place in 2006. Remember the 5 year ROTH clock to avoid taxes on the earnings and to avoid early distributions on the whole conversion amount restarts for those converted account, and therefore you cannot take a distribution of these funds without the 10% penalty (or valid exception to those penalties) till 2011. You need to keep track of these 5 year periods for each year you make a ROTH conversion.

    The reason you cannot just contribute to a ROTH SEP IRA is that you cannot convert the amount if your AGI is more than 100,000 for the year of the conversion. However, you can contribute to your SEP at that income level.

  10. Of course, one good recommendation for anyone who is self employed, or are considering a ROTH conversion… you should order Publication 560 and 590 from the IRS. You can download it from thier site or have it mailed to you for free.

  11. Anon – If you have self-employment income, why wouldn’t you file a Schedule C? There has to be something you want to deduct. Even driving to get office supplies is deductible.

    Artie – Thanks for the helpful replies. I still think they could have just make a different ceiling for Roth SEP IRAs like they did for Trad. and Roth IRAs, but hey as long as it works I’m happy.

    Definitely the IRS is the original source for all things tax, but reading those publications can be painful.

  12. christopher yu says:

    (I am a spammer)

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