Should you consider a Roth IRA Conversion?
Moving your money held in a Traditional IRA into a Roth IRA is called a “Roth IRA Conversion.” Many people choose to do a Roth IRA conversion because Roth IRAs have a tax advantage over Traditional IRAs in that the distributions are not taxable income. During the conversion process, the money you rollover from a Traditional IRA into a Roth IRA is added to your annual taxable income for that year.
When you pay taxes on the money you rollover, you pay taxes on the current value of the money, making it possible to take advantage of economic down turns through a Roth IRA conversion.
Future distributions from the newly created Roth IRA will be the same as any other Roth IRA, which is to say, they will be nontaxable. Investors who are in a low tax bracket often decide to invest using Roth IRAs because they expect to be in a higher tax bracket when they retire. Paying taxes on the money in a lower tax bracket will save money over paying taxes later when you are in a higher tax bracket. Many people choose to convert a Traditional IRA into a Roth IRA when the economy is struggling because their Traditional IRA will have less value than in strong economic times and it results in a lower taxable amount.
Who is Eligible for Roth IRA Conversions?
You must meet a few eligibility requirements for converting a Traditional IRA into a Roth IRA, including:
- Living separate from your spouse for the entire year if your tax filing status is “married filing separately”.
- Your modified adjusted gross income must be less than $100,000 in the years before 2010.
- You cannot convert a Traditional IRA if you inherited it from someone other than a spouse.
- You can convert Traditional IRAs to Roth IRAs even if you have made a rollover within the same year.
- You can convert a portion of the Traditional IRA into a Roth IRA but not just the nontaxable part.
Two Options Converting Traditional IRAs into Roth IRAs
There are two ways to move money from a Traditional IRA into a Roth IRA. You can rollover the funds yourself by taking a distribution from the Traditional IRA and rolling it into a Roth IRA within 60 days; or you can contact the bank or broker who manages your Traditional IRA and instruct them to transfer the money into a Roth IRA for you.
Whether you choose to rollover the funds or do a transfer, it’s necessary that you use the entire Traditional IRA distribution amount to fund the Roth IRA to avoid early withdrawal penalties and fees. You can’t decide to keep some of the money out as pocket cash or to take a vacation, for example.