Contribution vs. Conversion: The Key Differences
Roth IRA contribution vs. conversion comparison
| Factor | Roth IRA Contribution | Roth IRA Conversion |
|---|---|---|
| Source of funds | New after-tax dollars from earnings | Existing pre-tax IRA or 401(k) funds |
| Annual limit | $7,000/$8,000 per person | No limit — convert any amount |
| Income limit | Phase-out $150K-$165K (single) | No income limit |
| Tax treatment | No deduction; no tax at withdrawal | Pay ordinary income tax on converted amount |
| Best for | Current savers below income limit | Pre-retirees with large traditional IRAs |
| Effect on balance | Adds new money to Roth IRA | Moves existing IRA money to Roth IRA |
When Each Strategy Makes Sense
Direct contributions are ideal when you have current earned income and are in a moderate tax bracket (12-22%) — you are paying tax now at a relatively low rate on new money. Conversions are ideal when you have large pre-tax IRA balances and are in a low-income period (early retirement, between jobs) — you pay tax at currently low rates on money that would otherwise face potentially higher RMD tax in the future.
Convert $50,000 at 22% rate: pay $11,000 now. That $50,000 grows at 7% for 20 years to $193,000. If it stayed in Traditional IRA and was withdrawn at 25% rate: $48,250 tax owed. Breakeven in years: $11,000 upfront vs. $48,250 later — conversion wins if you live long enough and rates stay the same or rise.
- Contribution advantage: No immediate tax cost — money goes in after-tax and grows tax-free from day one
- Conversion advantage: No annual contribution limit — can move hundreds of thousands in a single year
- Both strategies compound identically once in Roth IRA — the difference is entirely the entry cost
- Optimal combined strategy: maximize annual contributions (7K) PLUS convert additional traditional IRA funds in low-income years
- Never convert in a high-income year when you would be taxed at 32-37% — the breakeven may never materialize
Model Your Roth Contribution or Conversion Growth
Calculate the long-term value of moving money into your Roth IRA through either contributions or conversions.