Published Tuesday, December 2, 2014 at: 7:00 AM EST
The hubbub over Roth IRA conversions continues unabated. Many who haven't taken the plunge are debating whether to use this technique, while others who already have transferred traditional IRA funds to a Roth are looking to feather their growing nest egg. Barring any radical changes in the tax law, a conversion remains a workable option for knowledgeable retirement-savers.
What's the driving force behind the conversion trend? The reasons may vary from one person to the next, but there are essentially four main types of conversions: strategic, tactical, opportunistic, and hedging.
First, let's examine the roots of a Roth conversion. With a traditional IRA, you can build up your account with contributions that may be partially or totally tax-deductible, in addition to amounts that are rolled over tax-free from an employer's retirement plan such as a 401(k). But distributions are taxable at ordinary income tax rates to the extent they represent deductible contributions and earnings. What's more, you must begin taking required minimum distributions (RMDs) from an IRA in the year after you turn age 70½.
In contrast, contributions to a Roth IRA are never tax-deductible, and you have to pay tax on a rollover from an employer plan. But the tax benefits come fast and furious on the back end. "Qualified" distributions - those made after age 59½, on account of death or disability, or used to pay first-time homebuyer expenses, up to a lifetime limit of $10,000 - from a Roth that's at least five years old are completely exempt from federal income tax. Other payouts are taxed under special "ordering rules," which treat amounts as coming first from nontaxable contributions.
To top things off, you don't have to take distributions from a Roth IRA during your lifetime. That can help preserve your nest egg for the benefit of your heirs.
The money you convert from a traditional IRA to a Roth is taxable as income, and that negates some of the benefits of transferring those funds.
Why convert? Here's a quick breakdown of the four main types of Roth conversions and the reasons for converting:
Regardless of the type of conversion, deciding whether to convert needs to be based on relevant economic variables and a thorough analysis of your particular situation. Typically, you'll need to take into account factors such as your current and projected tax rates; whether you'll need account assets to pay living expenses during retirement; current age, investing timetable, and health status; and whether you'll need to tap your IRA funds to pay for part or all of the conversion tax. We can help you make a sound decision.
This article was written by a professional financial journalist for Preferred NY Financial Group,LLC and is not intended as legal or investment advice.
An individual retirement account (IRA) allows individuals to direct pretax incom, up to specific annual limits, toward retirements that can grow tax-deferred (no capital gains or dividend income is taxed). Individual taxpayers are allowed to contribute 100% of compensation up to a specified maximum dollar amount to their Tranditional IRA. Contributions to the Tranditional IRA may be tax-deductible depending on the taxpayer's income, tax-filling status and other factors. Taxed must be paid upon withdrawal of any deducted contributions plus earnings and on the earnings from your non-deducted contributions. Prior to age 59%, distributions may be taken for certain reasons without incurring a 10 percent penalty on earnings. None of the information in this document should be considered tax or legal advice. Please consult with your legal or tax advisor for more information concerning your individual situation.
Contributions to a Roth IRA are not tax deductible and these is no mandatory distribution age. All earnings and principal are tax free if rules and regulations are followed. Eligibility for a Roth account depends on income. Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).
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