Avoid The 5 Most Common Roth IRA Conversion Mistakes

September 26, 2023

Mat Sorensen

So, you’ve decided to commit to a Roth conversion. There are a few things to know before you begin submitting your requests to your current custodian. There is a right way and a right time to do a Roth conversion. When you decide to do a conversion, you want to do it strategically to avoid a huge tax bill. Directed IRA has been assisting people with their conversions for years, and we’ve identified 5 common mistakes we see clients make when they elect to do their Roth conversions.

Let’s jump in.

Mistake #1: Converting everything in one year.

We see clients request a conversion of their full, pre-tax account regularly. Converting the entire account at once can be costly. Clients do not have to convert everything at once or in one tax year.

By breaking up the conversion over time, they lessen their tax burden and spread it out over a few years. This is referred to as “chunking.” If you are unsure of how much to convert to complete a successful conversion, contact the team of tax attorneys at KKOS Lawyers or consult with your CPA. They can walk you through your specific tax scenario to show you the best way to complete a neutral Roth conversion (little or no taxes paid may be possible).

The trick is to look at the tax bracket you are in and convert just enough before you’re pushed into the next, higher tax bracket. Your CPA can get specific with you on how much to convert while identifying additional deductions that you qualify for through your business, investments, and more to balance your tax bill out to a reasonable amount or to nothing.

Mistake #2: Paying the taxes due out of the Traditional account when you convert.

If you have the resources, do not pay your Roth conversion taxes with your IRA dollars! Taxes are not due at the time of the conversion, although you can elect to pay them at the time of conversion. Taxes are due when you file taxes for the year in which you did the conversion. This can give you several months to plan for how you will pay the taxes using personal dollars instead of your tax-deferred and now tax-free IRA dollars, depending on when you request the conversion.

You’ve worked hard to get retirement dollars into your accounts, so don’t use those dollars for anything but investments if you can afford to do so.

Mistake #3: Assuming you’re going to make less next year, so you wait to convert next year.

We hear this scenario every day… clients choose to not convert this year because they assume they will make less the following year. As you can imagine, this sometimes works in the client’s favor, but for the majority of clients it simply delays the ability for you to move things to a tax-free position in a Roth IRA. Begin your conversion today and don’t delay, as you can “chunk” the conversion out over the next few years (as discussed under Mistake #1).

We also hear clients express that they “make too much money” to convert. This is a common misconception we are happy to clarify. There are no income limits when you convert. This often causes confusion for our clients since there is an income limit when contributing directly to a Roth IRA. Keep this in mind next time you are doing a tax planning session, as you are not alone in believing this myth.

Your Roth conversion can be tax neutral. You can make this happen by chunking your IRA (converting a small portion of your pre-tax funds over a few years) and start earning tax-free now instead of several years from now… or never if you get analysis paralysis.

Mistake #4: Trying to convert on April 15th (with extensions occurring when the 15th lands on a Saturday, Sunday, or a holiday) for the prior tax year.

Conversions are taxed in the year in which they are processed. If you request a conversion on March 1st, taxes on the converted amount, if applicable, will be due when you file taxes the following year.

Tax time is stressful for a lot of people, but we want you to be ready, so you don’t have to get ready for tax time. Meet with your tax professional as early as you can so you can map out your strategy and save more efficiently.

A common mistake people make is meeting with their tax professional in January-March before the April 15th tax deadline. If you meet with your tax professional at that time, you must also keep in mind that any conversions you do in those months will be taxed and addressed the following year and NOT in the year in which you make the request.

This is a common misconception, as you can contribute to an IRA for the prior year up until April 15th.

Mistake #5: Thinking there is a single, “easy” button.

Although the overall Roth conversion process is quite simple, we see our clients try to skip a few steps in the process. This can cause unnecessary delays in completing a conversion.

To convert to a Roth IRA, you must have a Roth IRA established first. We cannot move the assets from your pre-tax account without having somewhere for it to land first. If you already have a pre-tax account with Directed IRA, you will just need to establish a new Roth IRA before you submit the Roth conversion request.

In addition, to having a Roth IRA ready to receive the converted assets, you will also want to meet with your CPA or other tax professional to determine how much you can convert before bumping yourself into a higher tax bracket. This will ensure you can convert while keeping it tax-neutral and identify additional strategies to reduce your tax bill.

If you aren’t sure where to start, contact Directed IRA for further guidance and step-by-step instructions on how to convert your account in the most beneficial way possible for your tax situation.

Bonus Mistake: I have real estate in my IRA, and I can’t convert it.

Whether your IRA is liquid or invested, you can convert the holdings. That’s right—even if you own a property, precious metals, or do a private loan through your account you can still convert it at any time, this is called an in-kind Roth conversion. To convert assets that are illiquid, there is one additional step in the process:

Converting Cash:

  1. Establish a Roth IRA
  2. Submit the Roth Conversion request.

Converting Assets:

  1. Establish a Roth IRA
  2. Obtain a valuation or appraisal for your IRA’s assets
  3. Submit the valuation and Roth Conversion request.

For example, if your IRA holds real estate, you will need to obtain a recent appraisal (dated within the last 60 days). Once you provide the updated value to us, you can convert all or some of your holdings. This ensures we convert the proper amount and value for you and allows us to accurately report it to the IRS on your behalf.

We hope this helps you navigate the world of Roth conversions!

Contact the team at Directed IRA for further assistance. We are open Monday through Friday from 8 AM to 5 PM Arizona Time.

Our committed team can be contacted at 1-800-818-1322, and we are ready to assist you in achieving a financially stable future.

If you need to establish a new account, enter this discount code to receive $50 off your first year’s annual fee: BLOG50.

Thank you for reading along!

Mat Sorensen

Mat Sorensen

Mat has been at the forefront of the self-directed IRA industry since 2006. He is the CEO of Directed IRA & Directed Trust Company where they handle all types of self-directed retirement accounts, which are typically invested into real estate, private company/private equity, IRA/LLCs, notes, precious metals, and cryptocurrency. Mat is also a partner at KKOS Lawyers. He is published regularly on retirement, tax, and business topics, and is a VIP Contributor at Entrepreneur.com. Mat is the best-selling author of The Self-Directed IRA Handbook, the most widely used book in the self-directed IRA industry.