Roth Conversion Early in the Year
By Kaye A. Thomas
Current as of January 14, 2015
If you’re doing a Roth conversion, it may be advantageous to do it early in the year.
You can do a Roth conversion whenever you want, but there are advantages to doing a Roth conversion early in the year.
- This page is adapted from Chapter 24, Conversion Strategy Fundamentals, of our book, Go Roth!
Paying the tax
One advantage of doing a Roth conversion early in the year has to do with the due date for paying tax on the conversion income. If you convert in January you won’t have to pay that tax until about fifteen months later. Your Roth can be generating tax-free earnings more than a year before you have to come up with the conversion tax. You’ll pay tax on a December conversion only about four months after the transaction. The difference won’t be quite this great if you have to make estimated payments covering tax on the conversion income, but even then some of the advantage of an earlier conversion usually remains.
This advantage applies whether you’re converting to a Roth IRA or doing an in-plan conversion of a traditional 401k or similar account to a Roth account within the plan.
More time to change your mind
Another advantage from converting early in the year comes from the opportunity to undo a conversion if your investments perform poorly afterward. Your deadline for this choice is October 15 of the year after the conversion. That means you get as many as twenty-one months of hindsight for a conversion in January, but only about ten months for a conversion in December.
This advantage applies only when converting to a Roth IRA, because the recharacterization rules can be used to undo these conversions. You aren’t allowed to undo an in-plan Roth conversion.
Five-year waiting period
There’s one factor that points the other way. Converting late in the year, rather than waiting until next year, may allow you to satisfy the five-year period for qualifying distributions, or the five-year period for avoiding a 10% early distribution penalty, a year earlier. That’s because these five-year periods are measured from January 1 of the year the relevant event occurs. These considerations aren’t always relevant, however, and you can start the clock running for qualified distributions with a small conversion before year-end and then convert the rest early in the following year.