Frequently Asked Questions about Converting a Roth IRA
Frequently Asked Questions about Converting a Roth IRA
Why should I convert to a Roth IRA?
Am I eligible to convert?
What can I convert or roll over to a Roth IRA?
How much should I convert?
How should I plan to pay for taxes resulting from a conversion to a Roth IRA?
Why should I convert now?
What are the advantages and risks of the 2010 tax deferral opportunity?
Can assets from my workplace retirement account be rolled over directly to a Roth IRA?
What if I am over 70½ and need to take a required minimum distribution (RMD)?
Can I change my mind?
When should I convert?
What are the next steps?
Why should I convert to a Roth IRA?>
Roth IRAs offer tax-free growth potential and withdrawals1, which may help minimize taxes and maximize retirement savings. The decision to convert needs to be made with care and should include a consultation with your tax advisor.
There are several factors to think about when considering a conversion to a Roth IRA. Three of the most important are taxes, time and cost.
Taxes
You may want to consider conversion if any of the following situations apply to you:
- You think your tax rate will be higher in retirement than it is today,
- Your taxable income is lower this year than in a typical year, or if you have accounts which have lost value, or
- You plan to leave your assets to your beneficiaries.
Time
You may benefit from a Roth conversion if you have 10 years or more before you'll begin to take withdrawals. Based on other key considerations, some investors with a shorter time horizon may also benefit from conversion. Consult your investment executive or tax advisor for assistance with determining if the timing is right for a Roth IRA conversion.
Cost
You are more likely to benefit from a Roth conversion if you can pay for the tax cost of conversion with cash or other non-retirement savings. Additionally, unless you elect otherwise, half of the income resulting from a conversion this year will be included as income in 2011 and the remaining half in 2012.
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Am I eligible to convert?
Effective January 2010, the income limit has been removed. A provision in the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) will allow more people to convert to Roth IRAs by removing the modified adjusted gross income limitations (MAGI) on conversions from a Traditional IRA to a Roth IRA. Under the provision, you may be able to spread your tax liability on amounts converted in 2010 over the 2011 and 2012 tax years. Contact your tax advisor to learn more about your options.
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What can I convert or roll over to a Roth IRA?
The following account types may be eligible for conversion to a Roth IRA:
- Traditional IRA
- Rollover IRA
- SEP IRA
- SIMPLE IRA
- SAR–SEP IRA
- 401(k)
- 403(b)
- 457(b)
How much should I convert?
Since you will have to pay taxes on the amount of money you are converting into a Roth IRA, you will most likely want to minimize the total cost of conversion. You may want to consider how much money you have set aside in non-retirement sources to pay the resulting taxes when determining the amount you would like to convert. Another money-saving option to consider is converting over a number of years (tax periods) in amounts that will keep the income from the conversion within your current tax bracket, or within a federal tax rate that you are comfortable with.
How should I plan to pay for taxes resulting from a conversion to a Roth IRA?
Consider not using the proceeds from the conversion to pay the resulting tax costs to help maximize your retirement savings. Using funds from the retirement account to pay the taxes will reduce the amount you would have available to potentially grow tax-free in your new Roth IRA. Furthermore, if you are under 59½, using funds from your retirement account could result in an additional 10% tax penalty which may significantly reduce the potential benefit of conversion.
Consult your tax advisor.
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Why should I convert now?
A conversion to a Roth IRA requires you to include taxable assets you're converting in current income and enables you to avoid future federal taxes on any subsequent Roth IRA earnings and withdrawals (if certain conditions are met). If you think your tax rate will be the same or higher than your current rate when you withdraw your money, it may make sense to pay the tax liability now, in exchange for the opportunity for federal tax-free growth and future distributions. There are no required minimum distributions (RMDs) during the lifetime of the original owner.
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What are the advantages and risks of the 2010 tax deferral opportunity?
While you should weigh this option carefully and consult your tax advisor, the risks associated with deferring taxes over 2011 and 2012 may outweigh the benefits.
Potential advantages of deferring
- Beginning January 2010, there will no longer be an income limit on Roth IRA conversions.
- If you convert in 2010, you will also be able to spread the tax payment over the next two years (2011 and 2012).
Potential risks of deferring
- If you choose to take advantage of the two year tax spread, you will lose the ability to change your mind after the 2011 Oct. 15 filing deadline.
- State tax laws may treat conversions differently than federal, resulting in a higher than anticipated additional state tax in 2010, or adding more complexity to your state tax filing.
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Can assets from my workplace retirement account be rolled over directly to a Roth IRA?
Yes. If you qualify, you can roll over assets from your 401(k) directly to a Roth IRA, eliminating the need to roll into a Traditional or Rollover IRA and then convert to a Roth IRA. You will owe taxes on the amount of pre-tax assets you roll over.
However, if you have assets in a Roth Designated Account (i.e., Roth 401(k)) and would like to roll these to an IRA, you can only do so to a Roth IRA.
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What if I am over 70½ and need to take a required minimum distribution (RMD)?
If you are required to take a distribution, you must take it before converting to a Roth IRA. Converting to a Roth IRA will not satisfy your RMD, so you will need to take your RMD before you convert.
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What are the tax implications of converting?
You will owe taxes on the amount of your IRA that's converted. However, unlike Traditional IRA withdrawals before age 59½, there is no penalty involved.1
Consider these questions:
- Do you have the money set aside in a non-retirement account to pay the tax?
- How much you can convert without moving up into a higher tax bracket?
Keep in mind:
- Using funds from the retirement account you are converting will reduce the amount of money you will have in your Roth IRA.
- If you are under 59½, using funds from the retirement account you are converting may result in a 10% tax penalty that may significantly reduce the potential benefit from the conversion.
- If you convert in 2010, you will also be able to spread the tax payment over the next two years (2011 and 2012).
Consult your tax advisor.
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Can I change my mind?
One of the most attractive features of a Roth IRA is the ability to revert back into a Traditional IRA if your situation changes and one or more of the following conditions apply:
- You won't have enough cash to cover the tax bill.
- The additional income that is the result of converting a traditional IRA into a taxable Roth IRA contribution puts you into a higher federal tax bracket.
- Your Roth IRA investments have lost money since you converted.
- Your taxable income is higher than you expected.
Consult a tax advisor to fully understand the regulations governing conversions.
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When should I convert?
The decision to convert early or late in the year depends on many factors. Keep in mind, the deadline to convert to a Roth IRA is December 31st in any calendar year.
- It may make sense to convert early in the year if you know what your income will be for the rest of the year, or you know you're going to be in the top tax bracket.
- You might want to consider waiting until you have a clearer picture of your finances if you're not sure how much you're going to earn for the year.
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What are the next steps?
The decision to covert to a Roth IRA is not a simple one. Before you begin the process, there are some things you can do to prepare:
- Create a retirement plan or review the one you have with a Capital City Banc Investments Executive (schedule a complimentary portfolio review by contacting your local investment executive – hyperlink “investment executive” to the associates page)
- Consider consolidating your accounts to simplify your finances and make it easier to manage your investments.
- Determine how you plan to pay the taxes created by your conversion.
Qualified Roth IRA distributions are not subject to state and local taxation in most states and are also federally tax-free provided a Roth account has been open for at least five years and the owner has reached age 59 ½ or meets other requirements. Roth IRA distributions may be subject to a 10% Federal tax penalty if the distribution is taken prior to age 59 ½.
Unless the investor elects otherwise, half of the income resulting from the conversion will be included as income in 2011 and the remaining half in 2012. Registered Representatives of INVEST Financial Corporation are not tax or legal advisors. Consult with your own tax and legal advisors before taking any action that may have tax or legal consequences.
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