What you need to know about Fidelity Roth conversions 

Roth accounts are popular because they offer several advantages. Investors can make tax-free contributions, while earnings on the account and withdrawals made during retirement are also tax-free. Even better, taking Required Minimum Distributions (RMDs) is no longer mandatory beyond 2024, due to the provisions in the SECURE Act 2.0.  

When it comes to retirement planning, one of the financial institutions that stands out is Fidelity Investments. Fidelity Investments remains a trusted institution that offers Roth accounts which can be invaluable for investors to build a secure financial future.  

But as with any investment decision, it is important to understand the nuances of converting to a Fidelity Roth IRA. This can be crucial for investors to make the most informed choices that will align with their long-term financial goals.  

So how can you do a Roth conversion with Fidelity? How do you convert a traditional IRA to a Roth IRA with Fidelity? What are the benefits of a Roth 401(k) conversion? In this article, we discuss the important considerations, tax implications, and strategic approaches to optimize your Fidelity Roth account. 

Why do a Fidelity Roth conversion? 

In general, doing a Roth conversion is a good strategy for anyone who wants to grow their retirement savings without having the gains taxed. Another motivation to do a Fidelity Roth IRA conversion is receiving tax-free income during retirement.  

Scenarios where a Fidelity Roth conversion makes sense 

The tax-free gains and tax-free withdrawals on earnings are motivation enough, but there are other factors (or scenarios) that make a Fidelity Roth conversion sensible for your clients:  

1. When the account owner can pay the taxes 

It’s important that the account owner has enough money to pay the taxes on the amount converted. Converting funds from a traditional IRA to a Roth IRA does not have to be the entire amount – the account owner can convert a portion of the funds.  

Investors should avoid using the money in the IRA to pay for the tax conversion. This may result in losing potential gains and undermining the purpose of the conversion.  

2. When there are losses and other deductions to lower the tax on conversion 

Should the account owner suffer business or property losses, this can be a good time to convert to a Roth. Tax deductions for income tax for the year can include:  

• Theft losses – these are defined as the removal and taking of property or money with the intent of depriving the owner of them. The value of the theft loss is the adjusted basis of the property since the fair market value (FMV) after the theft is deemed as zero 

• Casualty losses – these losses are due to damage, destruction, or complete loss of property from fortuitous events like an earthquake, fire, flood, hurricane, tornado, or volcanic eruption. Casualty doesn’t include everyday wear and tear nor progressive deterioration. Filing for a casualty or loss begins with IRS Form 4684 
• Other deductibles on income tax – for individual wage earners, this includes home mortgage interest payments, charitable contributions (up to a certain limit), medical expenses, expenses related to investment income, and unreimbursed job-related expenses.  

3. When the account owner is close to retirement 

A Roth conversion would make sense if the account owner is nearing retirement age. However, the best time to do a Roth conversion would have to be when they can wait at least five years before making withdrawals on earnings.  

Remember the five-year rule? This states that the Roth account should be in existence and have had its first contribution within a five-year period before withdrawing earnings. Breaking this rule results in a 10% penalty.  

There is no penalty on the withdrawals on earnings in a Roth if: 

• the account owner is aged 59½ or older 
• the account owner is permanently disabled 
• the Roth is inherited 
• the withdrawal is for buying, building, or renovating their first home 
• the withdrawal is for qualified birth or adoption expenses 
• the withdrawal is for paying qualified higher education 

4. When the value of IRA investments is low 

If the account owner’s investments in their traditional IRA are not earning as much, this may be a good time to convert their Fidelity account to a Fidelity Roth.  

With a Roth IRA, the account owner’s earnings may still be small, but they would not have to pay tax on their withdrawals later. This is a better financial situation than sticking with a traditional IRA.  

5. When the account owner moves to a state with higher taxes 

Income and other taxes can vary from state to state; some are higher, while some are lower or even nonexistent. When the account owner is on the verge of, or has moved to another state with higher taxes, a Roth conversion is advisable. The fact that Roth withdrawals are not taxed can cushion the impact of high income taxes of a state they choose to retire.  

6. When higher taxes are expected sometime in the future 

Some financial experts predict that there will be higher taxes when the 2017 Tax Cuts and Jobs Act expires at the end of the year 2025.  

Unless there are other provisions or revisions made to the tax law before then, the top tax bracket could be taxed as much as 39.6%. Meanwhile, the other lower tax brackets could see an increase of at least 4%. Considering this and the other factors, now seems like a good time to consider a Roth IRA conversion.  

Can a Roth conversion be reversed?  

Not anymore. It used to be possible to change a Roth account back to a traditional IRA, but the changes imposed by the Tax Cuts and Jobs Act of 2017 no longer allow this. Once a traditional IRA is converted to a Roth, there’s no way to reverse it.  

Is it possible to partially convert an eligible account at Fidelity? 

Yes, Fidelity account owners have the option to do a full or partial conversion to a Roth IRA from the following types of retirement accounts:  

• Traditional IRAs 
• Rollover IRAs  
• SEP-IRAs  
• SIMPLE-IRAs  

In addition, some workplace plans like the 401(k) may be eligible to roll over directly to your Roth IRA.  

What is the minimum amount required to open a Roth IRA account in Fidelity? 

There is no minimum amount or account fee to open a Roth IRA or other types of accounts with Fidelity. However, there are expenses charged by the investments themselves (i.e., mutual funds, managed accounts and some HISAs). Commissions, interest charges and other transaction fees may still apply.  

Step-by-step guide to converting to a Roth IRA at Fidelity 

The process of converting to a Roth IRA at Fidelity is simple and straightforward. Follow these steps. 

Step 1. Initiate the conversion.  

Start the conversion on the Fidelity website and click on the “Start a Roth Conversion” button. You can choose to convert accounts that are with other financial institutions as well.  

Important notes:  

• The deadline for Roth conversions is December 31 of the calendar year. Should that day be on a weekend, the processing deadline will be set at 4 p.m. ET of the year’s last business day. 
• You can use the Fidelity Calculator to determine your taxes for the conversion.  

Step 2. Choose the accounts for conversion.  

Step 3. Acknowledge and agree to the tax implications of the conversion.  

Next, check the tax that’s applicable to the amount of money converted. Fidelity gives investors the option of paying the tax out of pocket or withholding the tax on the conversion from the account.  

Withholding the money from the account to pay for the conversion is not advisable, since this means reducing the money in the Roth to grow tax-free.  

Step 4. Convert all the funds or a portion of it to a Roth.  

Depending on your clients’ financial goals and strategy, they can convert the entire amount or only a small portion of it into a Roth.  

Step 5. Review conversion details and approve conversion. 

The last step is to review all the details of the conversion, such as the accounts to convert, and the amounts. Click the “Submit” button then wait for a notification email, text, or call from a Fidelity representative confirming the transaction. 

The Pitfalls of a Roth IRA conversion 

Converting from qualified retirement plans to Roth IRAs is not a strategy that suits every investor. Investing involves risk, and there are some cases where a Roth conversion would not be advisable, or perhaps even detrimental to an investor’s financial or retirement goals.   

Here are some scenarios where a Roth IRA conversion would not make sense: 

1. When your client cannot comply with the five-year rule 

If your client needs money now and uses their traditional IRA to pay for their living expenses, converting to a Roth is not a good idea. This can saddle them with a hefty tax bill and a 10% penalty if they need to withdraw money. Their time horizon may also not be enough to allow the account to grow and recoup the cost of the conversion.  

2. The account owner is not 59½ years old yet and needs money 

Converting to a Roth can deprive them of their income, since they will have to satisfy the five-year rule on withdrawals. Taking money from the converted Roth gets them a 10% penalty, not to mention having to pay the conversion tax.  

3. The client is in their peak earning years 

If they are already high earners, converting to a Roth IRA may not be beneficial, since this can push them into a higher tax bracket.  

Note: this is not a Backdoor Roth IRA conversion 

The Roth IRA conversion discussed here is the type used to convert retirement accounts into Roth IRA accounts for the tax benefits. This is in stark contrast to the Backdoor Roth IRA, which is a legal workaround for high-income earners to bypass the contribution limits of their Roth accounts.  

The backdoor Roth conversion involves making an after-tax contribution to an IRA or 401(k) plan. The money is then converted to a Roth IRA without paying taxes. While it sounds easy, complex computations like the Pro-Rata Rule can apply if the Backdoor Roth consists of pre-tax and after-tax money.

Little-known benefit of the Roth IRA conversion  

Perhaps a little-known benefit of the Roth IRA conversion is that this can be used to potentially grow a sizable inheritance. Since RMDs are no longer mandatory for Roth IRAs, you can let the money in it grow its earnings, tax-free. However, once you pass away, your heirs will have to take RMDs, but these are likewise tax-free. The caveat is that this will only apply if the Roth account has existed for at least five years.  

The Fidelity Roth IRA conversion offers a lot of tax advantages. The key to optimizing this conversion is making sure that the conversion is done at the right time in the right conditions. Apart from timing the conversions, it’s crucial for the account owner to have a separate source of funds to cover the taxes.  

Paying for the conversion taxes from the Roth itself can undermine the move and make the account lose out on potential tax-free growth. Remember also that the conversion must align with your clients’ long-term financial and retirement goals.  

What do you think of Fidelity Investments as the handler for Roth IRAs? Don’t forget to check out other retirement planning topics here on InvestmentNews.