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Roth IRA Conversion

This article was written by in Investing. 3 comments.


The option to convert a Traditional IRA to a Roth IRA has been around for a while. Here are the differences between a Traditional IRA and a Roth IRA for those new to these retirement accounts. As long as your modified adjusted gross income (MAGI) is under $100,000 you have qualified for this conversion. Contributions to the Traditional IRA is tax-deductible, which means that your tax bill is calculated after ignoring the amount you deposit into the IRA. You will pay those taxes after you retire and begin withdrawing these funds. If you have a higher tax rate now than you will in retirement, the Traditional IRA is a good choice.

On the other hand, the Roth IRA is not tax-deductible, so the deposits into this type of IRA are not exempted from your total income calculation for tax purposes. In effect, you use “after-tax money” to invest in a Roth IRA. This is a great choice for people who believe their tax rate now will be lower than it will be in retirement once they begin taking distributions.

There are two other benefits to the Roth IRA that often go unnoticed. The Roth IRA does not require distributions after age 70 1/2 like the Traditional IRA, offering more flexibility in retirement. The Roth IRA is better for estate planning; choosing a Roth IRA rather than a Traditional IRA for funds passed onto your heirs will allow them to avoid tax bills.

These benefits come with a drawback: if your MAGI is above $105,000 ($166,000 for those who are married filing jointly) your maximum allowed contribution begins to reduce and will completely phase out at $120,000 ($176,000 for married filing jointly). But there is now a law that will help you get around this for a short time.

In 2010, the $100,000 maximum for Roth IRA conversions will temporarily disappear. If you believe the Roth IRA is a better option for you but you have been prevented from investing in this type of account due to income limitations, now is your chance to make the change. Here is why this will be allowed: When you convert from a Traditional IRA you owe taxes on the amount of the conversion, and the government would really like that income.

If you must pay those taxes using funds from your IRA, the conversion might not be a good idea, but if you have cash saved for the tax bill you will be better off.

You can also convert accounts known as SEP IRAs and SIMPLE IRAs.

Here are some quality resources regarding Roth IRA conversions.

Updated August 22, 2009 and originally published August 21, 2009. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 3 comments… read them below or add one }

avatar Gene South

Yes, as you say, “the government really would like that income.”

Then why doesn’t the government completely stop the traditional 401K and IRA, and only offer the Roth versions? Then they wouldn’t have to wait at all for any of “that income.”

The reason is that with the traditional retirement accounts we end up paying high ordinary tax rates on years and years of capital gains and dividends.

Very wealthy people like Dick Cheney, with most of their income outside retirement accounts, get favorable federal tax treatment on their capital gains and dividends. Maximum 15%.

So the government is willing to wait… and the little people get screwed. Dick Cheney is laughing all the way to the bank.

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avatar Shawanda

I also like the Roth 401(k). Although your employer has to offer this type of account in order for you to take advantage of it, you’re not subject to income limitations if you’d like to participate. You can always try to convince your employer to offer the option. Especially if there are a decent enough number of employees who’d be ineligible to participate in a Roth account otherwise.

“If you have a higher tax rate now than you will in retirement, the Traditional IRA is a good choice.”
I’m glad you mentioned this here. I hear a lot of financial experts making blanketed statements about a Roth being the superior retirement account. If you’re a high income earner nearing retirement and you’ve accumulated little to no assets, then there’s a pretty good chance your income is going to be lower when you retire. And as a result, your taxes will be too.

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avatar Britt

Excellent post!

In regard to the Roth IRA income limits, you state:

“But there is now a law that will help you get around this for a short time.”

However, I don’t think it was made clear to most readers that the law change on who can and cannot convert essentially eliminates the income restrictions on contributions.

Since income limits in regard to a Traditional IRA only apply to deductible contributions, high income earners who are ineligible to make direct Roth IRA contributions can make non-deductible contributions to a Traditional IRA. In 2010, when the income restrictions on Roth IRA conversions (currently $100,000) disappear, those same high income earners can convert the Traditional IRA to a Roth IRA, and they’ve effectively made Roth IRA contributions!

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