Roth IRA Conversion

Sometimes it can seem that a Roth IRA conversion is an obvious choice, and for many people converting a standard IRA account to a Roth IRA account makes a great deal of sense, as well as saving them a rather significant sum in tax. However, there are exceptions, and sometimes people have dashed from a standard IRA account only to find later that they are far worse off, and have lost out on several thousand dollars. To make sure that this doesn't happen to you, read on to learn more about Roth IRA conversions.

Many people seem to assume that if they are eligible to open a Roth IRA account, that somehow they are automatically qualified to convert their previous, standard IRA account into this new format, thereby saving themselves a bundle in deferred taxes. Sadly this isn't the case, and not everyone is able to make this type of conversion.

As you very likely know in order to qualify for a Roth IRA you must not have an income from which your contributions will be made, but your income must not exceed whatever the current limit is for that year. This depends not only on whether the cap limit has been raised in line with inflation, but other circumstances too such as whether you are applying as an individual, as a married couple, the head of a household, as a joint partner with the head of the household, or as an individual who is married but applying for separate accounts.

Having waded your way through this year's figures, you may well have discovered that you are eligible to open a Roth IRA account. But before you launch into transferring all your hard earned cash from your old IRA across to the new one, you may well find that your income is too high to permit you to carry out such a conversion.

That's right, for a Roth IRA conversion the income limit is actually lower than the limit imposed in order to just open an account. So, let's say you're applying for a married couple's Roth IRA, and as your combined income is less than $160,000, you've qualified for a Roth IRA and have opened an account.

Let's assume your combined income is $140,000, $20,000 under the limit for opening a Roth account. Certainly you could be forgiven for assuming that since you easily qualify to open a Roth IRA that you'll be able to simply convert your old IRA into a Roth account.

However, for both married couples and individuals the conversion limit for your MAGI, or Modified Adjusted Gross Income is just $100,000. That means that many couples are finding that they are ineligible to convert their IRAs to a Roth IRA.

Having looked at this lower income limit, if you still qualify - and for many individuals, rather than married couples, this is the case, then in all probability it is probably an excellent idea to do so. But just because you might have passed the income cap hurdle it doesn't mean to suggest you're out of the woods yet. There are still a few other matters to consider with a Roth IRA conversion. The first, for example, is the tax situation.

If you decide to convert a standard IRA into a Roth IRA then you will need to pay tax on the earnings your IRA will have made, as well as on any pre-tax contributions. Because you won't be paying taxes on your withdrawals from a Roth IRA (assuming that you fulfill the criteria at that time), then the tax payment made at the point of conversion is in lieu of these payments.

Some people assume that all they will do is to tap in to their IRA in order to pay this tax requirement, but this can prove costly. If you're under the minimum required age for making withdrawals, which is 59 and a half, then you will incur a 10% penalty on your withdrawal.

Another issue to bear in mind is that when you convert your old IRA to a Roth IRA you may well find that the income generated from this conversion, and which will be counted towards your total year's income, pushes you into a higher tax bracket. This might also prevent you from qualifying for a number of benefits you might otherwise have received or had been receiving, such as dependent child benefits and college tuition tax credits.

As a general rule of thumb, the closer you are to the age of 59 and a half the less of a good idea it becomes, since you're effectively reducing the amount of time you have available to make up for any loss incurred during the Roth IRA conversion. But if you do qualify, and you can accept the tax liabilities and won't be affected by any increase in your declared earnings for the year, then it's certainly a great way to provide tax free withdrawals for your retirement. But Roth IRA Tax can certainly spring a few surprises if you aren't careful. Back to "Roth IRA Rules"