Converting Traditional IRA to Roth IRA

Generally, in what’s called a ‘Roth Conversion,’ you can transfer all or a portion of your traditional IRA funds to a Roth IRA. However, just because you can convert or roll over funds doesn’t necessarily mean you should. There are a number of factors to consider.

Pros

1) Qualified distributions from Roth IRAs (including contributions and investment earnings) are tax and penalty free, if made at least five years after you first establish any Roth IRA, and if one of the following applies:

  • You have reached age 59 1/2 at the time of the withdrawal
  • Withdrawal is made:

1. Due to qualifying disability

2. To pay for first-time homebuyer expenses ($10,000 lifetime limit)

3. By your beneficiary after your death

The five-year holding period begins on January 1 of the tax year for which you make your first contribution to any Roth IRA. Each taxpayer has only one five-year holding period for this purpose.

2) Roth IRAs are not subject to the lifetime Required Minimum Distribution rules. With traditional IRA’s you are required to take taxable distributions beginning at age 70 ½.

3) Converting or rolling over funds may reduce your countable assets for federal financial aid purposes.

4) Qualified distributions from Roth IRAs are not included when determining the taxable portion of Social Security benefits.

5) There are no income restrictions when making a Roth IRA conversion. This can be used to overcome the income limit on annual contributions ($110,000 for Single Filers and $183,000 for Joint Filers).

6) There is no limit on the number of conversions made in a year.

Cons

1) You have to pay tax now on the funds that you convert or roll over, typically using non-IRA assets.

2) Using IRA funds to pay conversion tax has significant drawbacks.

3) “Non-qualified” distributions that represent earnings from a Roth IRA are subject to federal income tax and potentially a 10% early distribution penalty. The portion of a Roth IRA distribution that represents your contributions is never taxable (except for converted amounts which must be held for five years from January 1of the tax year in which you made the conversion).

4) Taxable income resulting from a conversion can increase the taxable portion of Social Security benefits.

5) IRA’s you’ve inherited from someone other than your spouse cannot be converted to a Roth IRA.

How to do it

1) Calculate the tax that will result from converting or rolling over funds.

2) Decide where the dollars will come from to pay the resulting tax.

3) Before deciding whether to convert or rollover, consider the investment holding period and compare your current tax bracket to your estimated tax bracket during retirement.

4) Whether you are converting or rolling over, check with the receiving custodian for instructions and forms to process the transaction.

Consult your tax professional and financial planner when deciding whether to convert or roll over your traditional IRA and take their advice and assistance when it’s time to make the change.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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