Overview

Converting a Traditional 401(k) to a Roth IRA is a deliberate tax decision: you trade a tax break today (pre-tax contributions and tax-deferred growth) for tax-free withdrawals in retirement. The immediate consequence is an increase in taxable income for the year of conversion — but if you expect higher tax rates in retirement, want more tax diversification, or prefer accounts that aren’t subject to required minimum distributions (RMDs), a conversion can be powerful.

In my practice working with clients across income levels, the most successful conversions were planned: partial conversions executed over several years during low-income windows, using outside funds to pay the conversion tax, and coordinating with projected Social Security, pension, or capital-gain events.

How a conversion actually works (step-by-step)

  1. Confirm plan rules. Not every employer plan allows in-service rollovers or Roth conversions. Contact your plan administrator to learn whether your 401(k) can be rolled directly to a Roth IRA, converted in-plan (to a Roth 401(k)), or whether you must first roll to a Traditional IRA and then convert to a Roth IRA.

  2. Choose the destination. Options include converting to a Roth IRA or converting within the plan to a Roth 401(k) (if offered). Rolling to a Roth IRA removes RMD requirements and widens investment choices; in-plan Roth conversions keep money inside the plan and may be important if you want creditor protections unique to some employer plans.

  3. Calculate the tax cost. The taxable portion includes pre-tax contributions and all earnings on those funds. That amount is added to your taxable income in the conversion year and taxed at your ordinary income rates. Roth conversions are permitted regardless of income level (no MAGI cap) — see IRS guidance on Roth conversions for details. (IRS: Rollovers and Roth conversions).

  4. Fund the tax payment. Ideally you pay the tax from outside savings (not the retirement account). Withdrawing taxes from the account reduces the amount that compounds tax-free and could trigger penalties if you’re under age 59½.

  5. Complete the paperwork. If rolling to a Roth IRA, request a direct trustee-to-trustee rollover to avoid withholding and early-withdrawal complications. Keep records of the conversion amount and the Form 1099-R you receive, and report the conversion on Form 1040.

  6. Monitor the five-year rules. Converted amounts have their own five-year clock for the 10% early-distribution penalty. Also, to withdraw earnings tax-free you must meet the Roth IRA 5-year rule and the age 59½ requirement (Publication 590-B explains these rules).

Timing and tax strategy: when to convert

  • Use low-income years. Years with unusually low taxable income (job loss, business downturn, gap years before Social Security or pension start) often provide the cheapest conversions. In these years you can convert larger chunks without pushing into a much higher bracket.

  • Partial conversions spread over time. Converting bits of the account across several tax years keeps each year’s taxable income lower and can reduce marginal tax rate creep.

  • Avoid years with large capital gains or one-time income events. A big sale, large bonus, or a year with large capital gains can inflate your bracket and make conversions costly.

  • Convert before expected tax-law increases or before you reach RMD age. Roth IRAs are not subject to RMDs during the original owner’s lifetime; converting before RMDs begin (typically age 73–75 depending on your birth year and law changes) can eliminate forced withdrawals and preserve tax-free growth.

Tax specifics to watch

  • No income limit to convert. Unlike Roth contributions, Roth conversions are allowed no matter how high your income. Verify current IRS guidance, but this remains accurate as of 2025 (IRS: Rollovers and Roth conversions).

  • The conversion amount is ordinary income. The taxable portion is subject to ordinary income tax rates, not capital gains rates.

  • Withholding and estimated taxes. If you convert and don’t have enough withholding, you may owe estimated taxes or face underpayment penalties. Plan to increase withholding or make estimated tax payments when executing larger conversions.

  • The 5-year conversion penalty rule. Each conversion starts a five-year period that determines whether converted amounts withdrawn before age 59½ are subject to the 10% early-distribution penalty. Check IRS Publication 590-B for the conversion-specific rules.

Common scenarios and examples

  • Low-income conversion window: A client who had a year between jobs with lower W-2 income converted $50,000 without changing his marginal tax bracket. He paid the tax from savings, and over the next decade that converted balance grew tax-free. This type of planning typically produces greater after-tax retirement income than letting the account grow tax-deferred into a higher-rate retirement life.

  • Partial conversions to manage brackets: Instead of converting $200,000 at once (which would push a taxpayer into a higher bracket), many clients convert enough each year to fill the gap up to the top of a desired tax bracket.

  • In-plan conversion vs. IRA roll: Some clients prefer an in-plan Roth 401(k) conversion because it keeps the funds in the plan with its creditor protections. Others prefer Roth IRAs for broader investment choices and the ability to avoid RMDs.

Practical dos and don’ts

Do:

  • Run projections for multiple tax years. Use the expected income for the conversion year, including Social Security, pensions, wages, and capital gains.
  • Pay the conversion tax with outside money. That preserves more of your retirement capital for tax-free growth.
  • Consider state taxes. State income taxes apply to conversions in many states; plan for both federal and state liabilities.
  • Coordinate with your CPA or tax advisor. Conversions affect tax credits, Medicare IRMAA surcharges, and other means-tested benefits.

Don’t:

  • Use converted funds to pay the tax unless you’re certain it won’t erode retirement resources or create penalties.
  • Convert during a high-income year or a year with large one-time taxable events.
  • Ignore the five-year and early-withdrawal rules if you’re under 59½.

Mistakes I’ve seen in practice

  • Failing to check plan rules. A client assumed their 401(k) allowed in-service rollovers and was surprised they first needed to separate employment.
  • Paying taxes from the converted account. It reduced long-term tax-free growth and, for clients under 59½, added early-distribution complications.
  • One large conversion that pushed the taxpayer into a new bracket, triggering higher tax and affecting eligibility for credits and premium subsidies.

When a conversion is not right

  • Near-term liquidity needs. If you’ll need the converted funds within five years, the combination of the 5-year rule and potential penalties can make conversions unattractive.
  • When you expect lower tax rates in retirement. If your projected retirement tax rate is lower than today’s, the cost of conversion may outweigh future tax savings.
  • If state taxes or other clawbacks (e.g., higher Medicare premiums) make the immediate tax pain too costly.

Recordkeeping and tax reporting

  • Form 1099-R: You’ll receive a Form 1099-R for the distribution from the 401(k) or IRA. It will show the gross distribution and the taxable amount.
  • Form 8606: Use Form 8606 to report nondeductible IRA contributions and to track basis, if applicable. It’s also used when reporting conversions when you have basis in Traditional IRAs.
  • Retain trustee-to-trustee rollover confirmation and conversion paperwork. Documentation avoids IRS confusion and substantiates that the rollover was direct.

Related reading and internal resources

Authoritative sources

Professional disclaimer

This article is educational and not individualized tax or investment advice. Tax rules change and your situation is unique — consult a CPA or fee-only financial planner before executing a conversion. In my practice, conversions work best when they are coordinated with a broader retirement tax plan that includes projected income, state tax considerations, and Medicare timing.