Roth IRA Conversion Basics

In 1997, Congress created the Roth IRA. With this type of individual retirement account, a taxpayer with qualifing income can make a yearly contribution that is not tax deductible; after age 59 1/2, a taxpayer may take tax-free distributions from a Roth IRA. There are no minimum required distributions after age 70 1/2 as there are with IRAs and employer retirement plans.

In addition to making annual contributions to the Roth IRA, taxpayers with adjusted gross incomes of less than $100,000 could also convert tax-deferred IRA and employee retirement plans into Roth IRA accounts. The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) allows for the conversion, or moving, of funds from these tax-deferred accounts into a Roth IRA in 2010 and beyond without the adjusted gross income limit of $100,000.

The most important decision point in considering whether to make a conversion of assets from a traditional IRA to a Roth IRA is to compare your current income tax bracket with your expected tax bracket when you anticipate taking future withdrawals. To start this analysis, you will need to familiarize yourself with a table of current marginal tax rates. If you think that you will pay more taxes in the future when it comes time to take withdrawals, consider converting to a Roth IRA now. If you think you will pay lower taxes in the future, consider leaving your traditional IRA alone. The Effect of Tax Rates on the Decision to Convert to a Roth IRA gives a comparison of various tax situations for both Traditional and Roth IRAs and illustrates the importance of comparing current and expected future taxes when making the conversion decision.

Other things to be aware of when considering a Roth IRA conversion:

• There are no income limits to do a conversion from a Traditional IRA to a Roth IRA.
• There is no maximum or minimum amount that can be or must be converted. Spreading out the conversion over several years may have tax benefits.
• Taxes must be paid on the amount of money that you convert to the Roth IRA in 2010. This can be done in two ways:
  
  
  1. In 2010, you pay taxes on the full amount that has been converted to a Roth IRA.
     or
     
  2. In 2010, you pay no taxes on the amount converted in 2010; however, you will pay one-half of the amount of taxes in 2011 and the other half in 2012.
  
  
• After 2010, taxes must be paid on the Roth IRA conversion amount in the year that the money is moved from a traditional IRA to a Roth IRA.
• Assets can be “recharacterized.” This means that you can place your funds back into a Traditional IRA if you change your mind about the conversion. You will get a refund of taxes you have paid on the converted funds.

Additional Roth Articles

• Taxes and Penalties on Roth IRA Distributions
  
• Effect of Tax Rates on Roth IRA Conversion
  
• Questions and Answers on Roth IRA Conversions