You have questions about converting to a Roth IRA. Let's get to the answers.
What is a Roth IRA conversion?
A Roth IRA conversion is a taxable movement of funds from a traditional, SEP, or SIMPLE IRA to a Roth IRA. You may also be able to roll over distributions from such qualified retirement plans as 401(k), 403(b), 457(b), and profit-sharing accounts into a Roth IRA. Because the Roth IRA has a different structure from the other account types, the benefits to you will be different.
Who is eligible to convert to a Roth IRA?
Anyone with a traditional IRA. In past years, there were many restrictions on Roth IRA conversion, but most of those were eliminated beginning on January 1, 2010. Tax filing status and income limits no longer apply to conversion, although they still apply to non-conversion Roth IRA contributions.
I have a SIMPLE IRA. What do I need to know?
You must wait two years between the date of your initial contribution and the time you convert to a Roth IRA. If you don't wait, you will have to pay a 25% tax penalty.
Can I convert an inherited IRA or qualified retirement plan into a Roth IRA?
If you inherited a traditional, SEP, or SIMPLE IRA account from your spouse, then you may convert it to a Roth IRA. However, both spouse and non-spouse beneficiaries can convert inherited qualified retirement plan (QRP) accounts, like a 401(k), directly to Roth IRA accounts.
What are the withdrawal benefits of a Roth IRA?
After you have held your Roth IRA for at least five years, and after you reach age 59 1/2, any distributions you take are tax-free. Unlike a traditional IRA, you do not have to take an annual minimum distribution at age 70 1/2.
What are some tax benefits of a Roth IRA?
With a Roth IRA, you make your contribution with after-tax dollars. That means you don't pay taxes on the distributions you take in retirement. If tax rates in the future are higher than rates today, you'll save money. Even if tax rates are the same, you won't have to deal with paying taxes on the distributions when you are retired. Furthermore, if you take a withdrawal after you have held your Roth IRA for at least five years, and after you reach age 59 1/2, you will not pay taxes on any earnings.
What are some estate-planning benefits of a Roth IRA?
Provided you own your Roth IRA for at least five years before your death, your beneficiaries will not have to pay tax on qualified distributions they receive from your Roth IRA when they inherit it. And because you don't have to take any minimum withdrawals from a Roth IRA, your money can continue to earn investment returns for longer, so you may have more money to pass on to the people you care about.
Will I owe any tax when I make the conversion?
If you received a tax deduction when you made your retirement plan contribution, you'll have to pay taxes when you convert to a Roth IRA. You can find the exact amount owed by using IRS Form 8606. The taxable amount of your conversion will be treated as ordinary income. Depending on where you live, you may owe state taxes, too; check with your tax advisor or the tax agency in your state. Also keep in mind that distributions of conversion amounts within the 5-year period following the conversion generally will be subject to the 10% penalty tax if under age 59 1/2.
Note: If you have made any non-deductible IRA contributions, the Pro-Rata Rule requires all IRAs to be treated as one, which includes traditional, SEP, and SIMPLE IRAs. It is not possible to convert after-tax (non-deductible) contributions with no income tax consequences.
Can I pay the tax with some of the money in my IRA now?
You can, but you may not want to. First, you lose out on having that money in your account to pay for retirement. Second, you'll have to pay a 10% penalty on the amount used to pay the tax if you are under 59 1/2.
Can I convert only some of my retirement funds?
Yes, you can do a partial conversion. There are two main reasons to do this. The first is that the taxable amount of the conversion will be taxed as ordinary income, and you may not want your conversion to put you into a higher tax bracket. Second, you will need the money to pay the taxes. If you do not have the funds to pay taxes when you convert your entire account, you may want to convert a smaller amount.
Can I move my converted retirement assets into an existing Roth IRA?
Yes, you can.
Do I have to take the required minimum distribution from my IRA before I convert it to a Roth IRA?
Once you reach age 70 1/2, you have to take the distribution each year. The required minimum distribution rules were waived in 2009, but they are back in force.
Is there a deadline for conversion?
No, you can convert your IRA at any time. You have to complete the conversion by December 31 to include the income in the current tax year; otherwise, the income will be included in the next year.
Can I make contributions to my converted Roth IRA account?
You must have earned income. In addition, in 2016, you must have an adjusted gross income of $184,000 or less for married couples filing jointly or of $117,000 or less if you are single or head of household. In 2017, you must have an adjusted gross income of $186,000 or less for married couples filing jointly, or $118,000 or less if you are single or head of household.
For more details, visit the IRS website.
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Prior to rolling over assets from an employer-sponsored retirement plan into an IRA, it's important that customers understand their options and do a full comparison on the differences in the guarantees and protections offered by each respective type of account as well as the differences in liquidity/loans, types of investments, fees, and any potential penalties.