ROTH IRA Conversions Print

Summary: Learn how to convert a Traditional or Rollover IRA into a ROTH IRA and under what circumstances a ROTH conversion makes sense.

ROTH IRA Conversions

 All taxpayers, regardless of their adjusted gross income (AIG), are now able to convert a traditional or Rollover individual retirement account (IRA) to a ROTH IRA. Prior to 2010, taxpayers with over $100,000 in AGI could not convert. This new conversion provision effectively removes income limitations from contributions to a ROTH IRA. In 2013, ROTH IRA contributions can be made by single taxpayers with AGI less than $112,000 (contributions are phased out with AGI between $112,000 and $127,000) and by married couples filing jointly with AGI less than $178,000 (contributions are phased out with AGI between $178,000 and $188,000). However, individuals with incomes over the limits can make contributions to a nondeductible traditional IRA and then immediately convert the balance to a ROTH IRA.

 

There are three main advantages of the ROTH IRA vs. a Traditional IRA:

  1. The ROTH IRA grows tax-free instead of tax-deferred.  All qualified distributions are tax free.
  2. There are no Required Minimum Distributions (RMD's) with a ROTH IRA at age 70 1/2 (or any age).  Therefore the account woner could let the money grow tax-free for the rest of their lives and leave it to their beneficiaries who would also never pay income tax when the money is ultimately withdrawn.
  3. The account owner can continue to contribute to a ROTH after age 70 1/2 which you cannot do with a traditional IRA.  You simply need to have "earned" income in order to make additional contributions.
     

There are a variety of factors that determine whether an IRA conversion to the ROTH IRA makes sense. Factors that favor converting include:

 

  • You will not use funds from the IRA to pay the taxes. You should not convert if you need to take funds from the IRA to pay the taxes.
  • You expect your future marginal tax rate (or your beneficiary’s) to be equal to or greater than your current marginal tax rate.
  • You don’t intend to take withdrawals from your ROTH IRA for many years.
  • You don’t expect to need withdrawals from you IRA. Since you aren’t required to withdraw funds from a ROTH IRA, even after age 70 ½, your IRA balance can continue to grow on tax-free basis.
  • You want to leave your IRA balance to Heirs. Once the balance is converted, a qualified distribution (i.e. withdrawal) cannot be taken for five years.  Distributions before five years are subject to a 10% early withdrawal penalty, unless one of the exceptions applies (first time homebuyer, death, disability, certain medical expenses, etc). In addition, each conversion carries it's own five year holding period.  Details can be found in IRS Publication 590.

The actual conversion process is quite simple.  In order to convert, you just fill out a form with the firm that holds your IRA (the custodian).  You will need to open a ROTH IRA account if you do not already have one and then assets can be transferred from the Traditional IRA to the ROTH.  You will get a 1099 for taxes showing the amount that you converted.  That amount will be taxed as ordinary income at your tax rate.  However, you can "undo" the conversion if you later decide that it was not a wise move.  Undoing the conversion is called a "recharacterization".  You can recharacterize (undo) the conversion up to the due date of your tax return (including extensions) for the tax year in which the conversion took place.

For More Information: If you have questions or comments about this or other financial issues, please contact Jeremy Kisner, CFP at (480) 272-7116. Mr. Kisner is the President of SureVest Capital Management (www.svwealth.com), a fee based financial planning and wealth management firm with offices in Las Vegas, NV and Phoenix, AZ.