Traditional IRA Conversion to Roth IRA
Beginning in 2010, the income limits on conversions from a Traditional IRA to a Roth IRA rules will no longer apply. Therefore, individuals making more than $100,000 will be able to convert their Traditional IRAs to allow the remaining funds to grow tax-free forever.
As a primer, Traditional IRA contributions are pre-tax dollars, meaning the contributions are not taxed in the current year. Those funds grow tax-free, but the distributions are taxed like ordinary income. Furthermore, at age 59 1/2, an individual is required to begin taking “required minimum distributions”, which are designed to exhaust the principal during an individual’s lifetime.
Roth IRA contributions are after-tax dollars. Therefore, the amount of the contribution is included in an individual’s income in the year of contribution. Like Traditional IRAs, the money grows tax-free. However, upon distribution, no taxes are paid. Furthermore, there is no minimum distribution requirement so discretion can be used to preserve the corpus of the Roth IRA during retirement.
To convert a Traditional IRA to a Roth IRA, an individual must pay the taxes on the Traditional IRA balance, effectively converting the pre-tax Traditional IRA contributions into after-tax Roth IRA contributions. The income taxes owed may be substantial. But, the further you are away from retirement, the more beneficial the conversion can be, as the after tax contributions will have a longer period to appreciate tax free.
But that isn’t the end of the good news; the income taxes due on the 2010 conversion can be spread over two years. So the 2010 conversion amount may be included as taxable income in 2011 and 2012 – helping to spread out the tax hit. Conversions in subsequent years are included in income during the tax year in which the conversion is completed.
Income limits still may prevent individuals from funding a Roth IRA. However, savvy individuals could continue to fund Traditional IRAs and roll them into Roth IRAs in subsequent years.
If you would like more information on the conversion of a Traditional IRA to a Roth IRA, please call or email Hoffman & Associates today.
404.255.7400
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