The top 10 Roth conversion mistakesArticle added by Jared Trexler on May 29, 2014
Jared Trexler

Jared Trexler

Philadelphia, PA

Joined: May 14, 2014

Here are the top 10 critical Roth conversion mistakes.


1. Making a contribution when you are not eligible.

There are income limits for making a Roth IRA contribution, and they are indexed for inflation. You also must have compensation (generally earned income) in order to make a Roth contribution.

2. Contributing more than the annual limit.

In 2014, the most you can contribute to a Roth IRA is $5,500 (plus an extra $1,000 if you are age 50 or over during the year). Any amounts you contribute to a traditional IRA will reduce the amount you can contribute to a Roth IRA, dollar-for-dollar.

3. Funds being moved from IRA to IRA get put in a Roth IRA instead.

This could be due to advisor or client error, or one made by your IRA custodian. Always make sure funds land in the right account. On the other hand, since this is technically just an accidental Roth IRA conversion, you can always re-characterize the money back to a traditional IRA by October 15 of the year following the year the mistake occurred — if the error has been discovered. Follow up to be certain.

4. Doing a "back-door" Roth conversion and not using the pro-rata rule.

When doing a Roth conversion that includes after-tax amounts, you must include the balances of all IRA accounts, not just the account being converted. The pro-rata formula can be found on IRS Form 8606, which must be filed with the account owner's tax return.

5. Incorrect valuation of assets when doing a Roth conversion.

Many tax scams are based on undervaluing assets. This is also true when it comes to Roth IRA conversions. A fair market value must be used for the asset converted. A common example is an annuity contract with riders. Such riders can increase the fair market value of the annuity contract, increasing the tax you will owe if you do a Roth conversion of the IRA annuity.

6. Shifting self-employment or business income into a Roth IRA to avoid income tax.

This was a popular strategy for several years, which the IRS has now made a listed transaction. It generally involves multiple entities and a self-directed Roth IRA. Eventually, earnings accrue to the Roth IRA and are never taxed as income — or at least that's what a number of taxpayers thought before the IRS and the Tax Court hit them with, in some cases, millions of dollars in penalties and interest.

7. Doing a re-characterization and not reporting the conversion/re-characterization on the tax return.

Sometimes people mistakenly believe that, since a full re-characterization effectively cancels out a Roth conversion, nothing has to be reported on their tax return. That's not true. Certain information, such as gross distribution reported on a 1099-R by a traditional IRA custodian for the conversion, must be reported on your tax return no matter what.

8. Doing a conversion directly from an employer plan to a Roth IRA and not reporting the conversion on the tax return.

This is generally an oversight. The 1099-R from the employer plan will have a Code G for a direct rollover to another plan. This is generally a non-taxable event, but now when the assets go to a Roth IRA. CPAs in the midst of tax season may overlook this unless you remember to tell them that your direct rollover was actually a Roth IRA conversion.

9. Beneficiaries of inherited IRAs not taking RMDs.

If you have your own Roth IRA account, there are no required distributions during your lifetime. When a non-spouse beneficiary inherits a Roth IRA, however, they do have required distributions beginning in the year after the account owner's death. The Roth IRA custodian is under no obligation to tell the beneficiary about those distributions or to calculate them.

10. The biggest mistake of all? Not having a Roth IRA in the first place.

You are never too old to do a conversion, and you are never too young to start contributing to either a Roth IRA or an employer Roth account.
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