Taxpayers may convert a traditional individual retirement account (IRA) to a Roth IRA regardless of modified adjusted gross income (AGI) or filing status. In order to decide whether a Roth conversion is appropriate for you, you need to understand the differences between these types of IRAs.
The major difference between traditional IRAs and Roth IRAs is the tax treatment of contributions and distributions. Qualified contributions to traditional IRAs are fully or partially deductible, and the contributions and earnings are not taxed until distributed. Contributions to a Roth IRA, although nondeductible when made, grow tax free and IRA assets (including earnings) are not taxed when distributed.
Funds in a traditional IRA (including SEPs and SIMPLE IRAs), §401(a) a qualified retirement plan, §403(b) tax-sheltered annuity or §457 government plan may be rolled over/ converted into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied.
If you already made a conversion earlier this year, you have the option of undoing the conversion. This is a useful strategy if the investments have gone down in value so that if you were to do the conversion now, your taxes would be lower. This is a complicated calculation and we should meet to determine what your best options may be.
In addition, for 2015, if your §401(k) plan, §403(b) plan, or governmental §457(b) plan has a qualified designated Roth contribution program, a distribution to an employee (or a surviving spouse) from such account under the plan that is not a designated Roth account is permitted to be rolled over into a designated Roth account under the plan for the individual.
Considerations for owners of Roth IRAs
Generally, converted assets in the Roth IRA must remain there for at least five years to avoid penalties and taxes. Distributions from a Roth IRA are tax-free and penalty-free provided that the five-year aging requirement has been satisfied and at least one of the following conditions has been met:
- You reach age 59½
- You pass away
- You become disabled
- You make a qualified first-time home purchase
MRDs are not required during the lifetime of the original owner of a Roth IRA. MRD amounts are not eligible to be converted to a Roth IRA.
To further explore the Roth Conversion strategy and the advantages and disadvantages as it relates to your personal planning contact us at 440-617-6697.