When it comes to building tax-free wealth for retirement, few tools are as effective as the Roth IRA. It allows your money to grow tax-free and come out tax-free in retirement, a combination that can dramatically reduce your long-term tax burden.
But understanding how to fund a Roth IRA is just as important as knowing why you should use one. But there are only two ways to fund a Roth IRA, and each comes with important rules and timing considerations. In some cases, especially when it comes to Roth conversions, making the wrong move could lead to an unexpected tax hit or costly mistake.
Let’s walk through the two methods for how to fund a Roth IRA and three situations where you should avoid a Roth conversion altogether.
How to Fund a Roth IRA: Contribution vs. Conversion
When learning how to fund a Roth IRA, there are two primary options: making a direct Roth IRA contribution or completing a Roth conversion. This method requires that you have earned income from a job or self-employment. However, not everyone qualifies. The IRS sets income limits each year, and your modified adjusted gross income (MAGI) must fall below those thresholds to be eligible to contribute directly. If your income is too high, you might still be able to get money into a Roth through a strategy known as the backdoor Roth IRA.
For 2026, the contribution limit is $7,500 per year, with an additional $1,000 allowed if you’re age 50 or older. These limits apply per individual and provide a powerful opportunity to grow wealth tax-free if you qualify.
The second method is a Roth conversion. Unlike contributions, conversions allow you to move money from a pre-tax retirement account, like a traditional IRA, into your Roth IRA. This maneuver is fully taxable, meaning the amount you convert is included in your taxable income for the year. However, once the money is in the Roth, it continues to grow tax-free and can be withdrawn tax-free in retirement. Roth conversions are an especially valuable strategy if you want to diversify your tax exposure in retirement or reduce future required minimum distributions (RMDs).
When a Roth Conversion Might Hurt You
While Roth conversions can be incredibly useful, the timing needs to be right. Converting at the wrong time could lead to higher taxes, lost benefits, or even early withdrawal penalties. One listener of The Wise Money Show asked whether they should proceed with a conversion during a year in which their income had spiked. This is an excellent question because it highlights one of the key reasons to delay a Roth conversion.
If your income is unusually high in a given year, due to a bonus, business sale, or a large capital gain, adding a Roth conversion on top of that income could push you into a higher tax bracket. Since the converted amount is treated as ordinary income, you’ll end up paying more tax than necessary. In many cases, it makes sense to wait until your income normalizes before converting.
Another situation to avoid is when a Roth conversion would cause you to lose eligibility for valuable tax benefits. Many tax credits and deductions—such as the Child Tax Credit, the American Opportunity Tax Credit, or even Medicare premium subsidies—are based on your modified adjusted gross income (MAGI). A Roth conversion raises that number and could push you past the income threshold for these programs. If that happens, you could end up paying more in taxes or losing out on significant benefits, which may outweigh the long-term advantages of the conversion.
A third reason to hold off on a Roth conversion is if you’re under the age of 59.5 and don’t have cash on hand to pay the resulting tax bill. While the conversion itself isn’t penalized, using part of the converted funds to cover the taxes is treated as an early withdrawal. For example, if you convert $20,000 but withhold $2,000 for taxes, that $2,000 is considered a distribution—not a conversion—and is subject to a 10% early withdrawal penalty unless you qualify for an exception. To avoid this problem, make sure you can pay the tax from another source.
How to Know When a Roth Conversion Makes Sense
The decision to convert to a Roth IRA shouldn’t be made in isolation. It requires careful evaluation of your full financial picture. Roth conversions touch on all six areas of financial planning, including tax planning, cash flow, retirement planning, investment allocation, insurance needs, and estate planning. That’s why it’s critical to work with a CERTIFIED FINANCIAL PLANNER™ who can help you weigh the pros and cons of converting, determine the right timing, and calculate the ideal amount to convert to fund a Roth IRA.
When done strategically, Roth conversions can significantly enhance your long-term financial flexibility and reduce your tax burden in retirement. But when done hastily or in the wrong year, they can do more harm than good.
If you don’t already have a CFP® helping you make these decisions, our team is here to help. You can reach us at korhorn.com or by calling 574-247-5898.
Ben deBock is a CERTIFIED FINANCIAL PLANNER™ at Korhorn Financial Group. He also holds his Chartered Financial Consultant (ChFC®) designation.
