By Kaye A. Thomas
Current as of January 19, 2021
You can do a Roth conversion whenever you want, but there are advantages to doing a Roth conversion early in the year.
There may be an advantage in doing a Roth conversion early in the year. If you’re thinking about a conversion later in the year, however, waiting until the following year isn’t necessarily the best choice.
- This page is adapted from Chapter 24, Conversion Strategy Fundamentals, of our book, Go Roth!
Paying the tax
The 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.
Five-year waiting period
If you’re thinking about a conversion late in the year, there’s a possible advantage in moving forward, rather than waiting until next year so you can do an early-year conversion. Acting now can start the clock on satisfying 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. There’s also a possibility your tax situation is more favorable for a conversion this year than it will be next year.
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.
Undoing a conversion
We used to say an early-year conversion had another advantage, because it gave you more time to wait before deciding whether to undo the conversion. This consideration is no longer relevant because the 2017 tax law prevents taxpayers from undoing post-2017 conversions.