Converting a traditional IRA

Retirement » Basics » Converting A Traditional IRA

There is no denying the benefits of converting money from a traditional IRA to a Roth retirement account.

Not only do the earnings in a Roth grow tax-free, but there's no minimum distribution age attached, allowing your money to work longer and harder during retirement.

Distributions from a traditional IRA, meanwhile, must begin by age 70 1/2.

Another Roth advantage is that you can take early withdrawals penalty-free (as long as the account has been open at least five years) for any reason -- as long as you limit your withdrawals to the initial principal.

Income earned from investments can also be withdrawn to cover qualified expenses, including the purchase of a first-time home, higher education or for medical insurance premiums during times of unemployment.

By contrast, distributions from a traditional IRA before age 59 1/2 will generally cost you a 10 percent penalty.

Who might benefit from a conversion?

  • Young workers who are in a lower tax bracket.
  • High-income earners ineligible to contribute directly to a Roth.
  • Individuals near age 70 1/2 who won't need the money within five years.
  • People who plan to pass on their IRA through an estate.

New rules under the Tax Increase Prevention and Reconciliation Act of 2005 mean there are no income limits on Roth conversions.

The removal of the earnings limit applies to conversions only.

The existing income ceilings remain in effect for new accounts and for contributions to an existing Roth IRA.

In 2014, single filers and heads of households can contribute the maximum if their income is below $114,000. After that, the contribution amount is phased out and tops out at incomes above $129,000. For married filing jointly, the phaseouts begin at $181,000 and top out at $191,000.

Who should think twice about converting?

  • IRA holders who cannot pay the tax bill with nonretirement savings.
  • People who may move into a higher tax bracket if they convert.
  • Older individuals who will need the money within five years.

Can you afford it?

Regardless of eligibility, however, a Roth conversion may not be right for you.

The process can be costly and complicated.

When you move money from a traditional IRA to a Roth, for example, you are required to pay income tax on the converted amount, which can be substantial.


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