Convert Your Traditional IRA to a Roth IRA

Did you know that you can convert your traditional IRA to a Roth IRA?  Many clients don’t know that option exists.  If you have a traditional IRA, or other type of employer-sponsored retirement plan, you have the option of converting your retirement accounts to a Roth IRA.  The conversion is rather simple, and you can choose to transfer some or all of your balance to your new Roth IRA.  But, why would you do that?

Why convert to a Roth IRA?

If you anticipate that your tax rate is likely to increase, converting to a Roth IRA can be a very promising move.  Roth IRAs provide tax-free withdrawals, so you avoid paying taxes when it is time to take money out for retirement.  Whereas, the tax benefits of traditional IRAs are seen when your contributions are made.  Also, if your earnings are too high to allow you to contribute to a Roth IRA, which has an income limit, for single individuals, of $116,000 (2015), then you may be able to use a conversion in order to still enjoy the tax benefits of a Roth IRA.

When should I make the conversion?

The best time to convert to a Roth IRA is when two factors come into play: your income is too high to contribute to a Roth IRA, but your tax rate will be higher when you retire.  Something else to consider is whether the conversion will cause you to be in a higher tax bracket or subject you to taxes you would not otherwise be required to pay.

How is the conversion done?

The most basic way to convert your retirement account to a Roth IRA is through a direct trustee-to-trustee transfer from one financial institution to another.  If your retirement account will remain with the same investment firm, the conversion is even easier.  Simply request that your traditional IRA be re-designated as a Roth IRA, as opposed to opening a new account.

How to avoid tax penalties

When making the conversion, it is important to be sure the funds are transferred directly between financial institutions.  If you are issued a check, you are required to withhold 20% for taxes.  But, if you deposit all of the money, including the 20%, into a new Roth account within 60 days, there will be no penalty.  If you miss the 60-day deadline, any funds that are not rolled over into the Roth IRA will be subject to a 10% early withdrawal penalty, in addition to the income taxes you owe on the entire converted balance.

The differences in a Roth IRA

The main differences between Roth IRAs and other retirement accounts can be found in the eligibility requirements, and the contribution and withdrawal rules.  A traditional IRA allows individuals who have earned income, younger than 70 ½-years-old, to make contributions.  However, a Roth IRA only permits contributions from individuals whose income falls within certain limits.  In determining eligibility, earned income is counted, which includes all money you are paid to work, including wages, salaries, tips, bonuses, commissions, and self-employment income.

If you have questions regarding a Roth IRA, or any other estate planning needs, please contact Wilcox Attorneys, PA online or by calling us at (479) 443-0062.