Roth IRA Conversion Rules

Can you convert to a Roth IRA?

One of the primary benefits of using a Roth IRA is that you don't pay income tax when you withdraw funds in retirement.

Unfortunately not everyone meets IRS standards to contribute to a Roth IRA. The primary reason individuals are not allowed to contribute is because their incomes exceed the Roth IRA income limits.

Many individuals that did not qualify for income reasons end up investing in 401k plans and Traditional IRAs. With a Traditional IRA you receive a tax break today, but pay income taxes in retirement. This is opposite of what happens with a Roth IRA. (Compare Roth IRAs and Traditional IRAs.)

The IRS has always allowed certain individuals to convert their Traditional IRAs to Roth IRAs as long as they met specific qualifications and paid income tax on the conversion. But high income earners were unable to convert until recently.

No Income Cap to Convert Traditional IRA to Roth IRA

In the past to be able to convert from a Traditional to a Roth IRA your income needed to be under $100,000. The IRS rules have changed and there is no longer an income cap in place.

With the cap removed high income earners can now convert as long as they pay the appropriate tax on the conversion. There is no 10% early withdrawal penalty if the funds move from the Traditional IRA to the Roth IRA in a 60 day window.

Roth IRA Conversion Taxes

When you convert from a Traditional IRA to a Roth IRA you pay income tax on the contributions. The taxable amount that is converted is added to your income taxes and your regular income rate is applied to your total income.

Any conversions done by December 31, 2010 will be allowed to spread the tax hit over the following two years. If you convert $100,000 you could add $50,000 to your 2011 income and $50,000 to your 2012 income.

After 2010 conversions will still be allowed, but the tax must be paid on the same year's income taxes. You will not be allowed to spread the tax over two years.

Why Convert to Roth IRA?

Tax savvy investors want to pay as little income tax as possible. Converting to a Roth IRA allows you to make smart tax moves that will save money in the long run.

If you anticipate your income dropping significantly in a certain year (and increasing in following years) then a conversion could be done in the low income year. Since your income is lower you may be in a lower tax bracket when you convert.

Likewise if the government announced increase tax rate increases to go in effect the following year then a conversion in the current year would save income tax.

Converting to a Roth IRA will guarantee you will owe no additional income tax on the converted funds during retirement. The balance in your portfolio will be what you can tap in retirement and you won't have to calculate an after-tax balance.

Convert to Roth IRA, Not Eligible

Even though high income earners can convert to a Roth IRA they may not be able to contribute additional funds. Roth IRA eligibility rules are still in place.

Compare provider options



TD Ameritrade

Name Fidelity Roth IRA Merrill Edge IRA TD Ameritrade IRA
Min Balance $0 $0 $0
Annual Fee $0 $0 $0
Fund Options 10,423 5,120 12,000
No Fee Funds 3,443 893 3,900
IRA Description Get a range of investment choices, tax advantages and 1:1 help with a Fidelity Roth IRA. Get up to $600 when you invest in a new Merrill Edge IRA. Plus one-on-one guidance, actionable insights and easy-to-use tools. Rollover your 401k or open and fund your IRA and get up to $600 cash. Get started today.
Post a comment

Important Roth Information

Each year, the IRS updates the rules for Roth IRA. Here are all the details for 2015 along with updates for 2016: