Before 2010, there were income restrictions as to who was allowed to convert to a Roth IRA. However, since then, the limits are no more and anyone can convert a traditional IRA to a Roth IRA at anytime. The difference between the two types of plans are when taxes are paid. Traditional plans are funded with pre-tax money (distributions will be taxed) while Roth options are funded with after tax dollars (distributions are generally tax-free).
There are two ways to move money from your traditional IRA to a Roth IRA: a rollover or a transfer. If you choose a rollover, you take a distribution in the amount you want to move. You then have 60 days to deposit the money into your Roth plan. Failure to meet this time frame will result in penalties. This is a decent solution if you need the money short term but will have it back within the 60 day period. If you choose to do a transfer, you never receive the money being moved. It goes directly from your traditional plan straight to your Roth IRA, even if you are switching custodians.
Whatever amount you convert will be considered taxable income. This would be the same if you simply took a distribution from your traditional IRA without converting it. If your traditional IRA has nondeductible contributions, you may prorate your conversion. So, if your IRA has 20% in nondeductible contributions, then that same 20% of your conversion will be tax-free.
Be careful of the tax trap that could see more money out of your pocket than necessary. It’s best not to use any of the money you are converting to pay the taxes that are due. The money you would use to pay the taxes is not converted and therefore is treated like a taxable distribution. If you are under age 59 1/2, you will owe a 10% early withdrawal penalty on top of the taxes due. Wait to perform the conversion until you have enough cash on hand to pay all the taxes.
When you transfer money to a Roth IRA, there’s a five year waiting period to withdraw the money penalty-free. Further, it must be a qualified distributions to avoid any penalty. These include permanent disability, first time home buying or after you reach age 59 1/2. Therefore, you cannot transfer the money to a Roth and then immediately withdraw from the account.
There are many factors in determining which type of IRA is best for you. The IRA experts at the IRA Financial Group can help determine if you are better off leaving money in a traditional plan or if a Roth conversion is right for you. Give them a call at 800.472.0646 to speak with a qualified professional!