Individual Retirement Account (IRA) Help
Created by the Taxpayer Relief Act of 1997, a conversion is a taxable movement of assets from a Traditional IRA (including a Traditional IRA that holds simplified employee pension (SEP) plan contributions) or a savings incentive match plan for employees of small employers (SIMPLE) IRA to a Roth IRA. For a SIMPLE IRA, an individual must satisfy a two-year waiting period, which begins on the date the employer deposits the first SIMPLE IRA contribution, before she may convert SIMPLE IRA assets to a Roth IRA.
Certain individuals may roll over their employer-sponsored retirement plan assets to a Roth IRA. See "What is an employer-sponsored retirement plan-to-Roth IRA rollover?" for more information.
The difference between a Traditional and Roth IRA can be summarized by the following comparison.
|Traditional IRA:||Regular contributions may be tax-deductible|
|Roth IRA:||No deductions|
|Roth IRA:||Tax-free if used properly|
|Traditional IRA:||Includable in taxable income|
|Roth IRA:||Tax-free for qualified distributions|
The Tax Increase Prevention and Reconciliation Act of 2005 eliminated conversion eligibility requirements beginning January 1, 2010. Therefore, anyone may convert eligible assets in an existing IRA or roll over employer-sponsored retirement plan assets to a Roth IRA without having to meet any Roth IRA eligibility requirements.
Read "How much can I contribute to a Roth IRA?" to learn about the eligibility limits.
You must include in your gross income all pretax assets converted to a Roth IRA. You will not, however, be subject to the 10 percent early distribution penalty tax.
EXAMPLE:Oliver has only made deductible IRA contributions to his Traditional IRA. In 2019, Oliver decides to convert $20,500 from his Traditional IRA to a Roth IRA. Oliver will need to include $20,500 as income in 2019.
If you distribute conversion assets within five years of the conversion, a 10 percent early distribution penalty tax will apply unless you have a penalty tax exception.
The following factors may play a role in determining whether a conversion of Traditional IRA assets or a rollover of employer-sponsored retirement plan assets to a Roth IRA is the right choice for you.
- Anticipated tax rate at retirement
- Years until retirement
- Current tax rate
- Earning rate assumptions
- Distribution plans at retirement
For some individuals, there are significant tax saving opportunities provided by the Roth IRA conversion option. Conversion to a Roth IRA is not, however, right for everyone. Use the conversion calculator to gain a better understanding of how various assumptions can affect your decision.
Effective January 1, 2008, individuals may roll over pretax and after-tax employer-sponsored retirement plan assets to a Roth IRA. Individuals could roll over retirement plan assets only to other retirement plans or Traditional IRAs before January 1, 2008.
Like IRA conversions, if you roll over retirement plan assets to a Roth IRA (excluding designated Roth accounts in retirement plans), you must include the taxable portion of the distribution in your gross income. Once you roll over these assets to a Roth IRA, they continue to grow tax-deferred. If you meet the requirements for a qualified Roth IRA distribution, you may distribute the earnings tax-free. If you do not meet the requirements for a qualified Roth IRA distribution, you may owe tax or an IRS penalty tax on some or all of the assets.
The IRA Conversion Analyzer is designed to help you decide whether to convert Traditional IRA assets or to roll over retirement plan assets to a Roth IRA. The IRA Conversion Analyzer contains three calculators to assist you in estimating future retirement accumulations. The following calculators provide general information and comparisons to illustrate the amount of savings you may have available after converting Traditional IRA assets or rolling over retirement plan assets to Roth IRAs.
- The Basic Conversion calculator estimates whether converting Traditional IRA assets or rolling over retirement plan assets to a Roth IRA will provide more funds at retirement.
- The Legacy Planner helps you determine if a Roth IRA will provide the greatest benefit to your beneficiaries.
- The Breakeven Analyzer estimates the point at which converting a Traditional IRA or rolling over retirement plan assets to a Roth IRA becomes the best option.
Each of the following factors determines whether a Traditional IRA or a Roth IRA is the right choice for you.
- Anticipated tax rate at retirement
- Years to retirement
- Current tax rate
- Earnings rate assumptions
- Distribution plans at retirement
- The Basic Comparison calculator estimates whether a Traditional IRA or a Roth IRA would provide more assets at retirement.
- The Legacy Planner estimates which IRA will best benefit your beneficiary after your death.
- The Breakeven Analyzer estimates the time frame when one type of IRA becomes more beneficial than the other to save for retirement.
The following charts explain the eligibility requirement for contributions.
|Eligibility Requirements for Contributions|
|Traditional IRA||1. Must have earned income
2. Must be under age 72
|Roth IRA||1. Must have earned income
2. Must be within limits
|Modified Adjusted Gross Income (MAGI) Limits for Roth IRA Contributions|
|Married, Filling Joint||$206,000|
|Married, Filing Separate||$10,000|
If your MAGI is under the applicable income limits, you may make a contribution to a Roth IRA as long as you have earned income.
You may annually contribute up to the lesser of
- 100 percent of earned income, or
- the statutory limit for the year ($6,000 in 2021)
The annual contribution limit is subject to cost-of-living-adjustments (COLAs).
In addition, if you are age 50 or older, an additional amount (called a catch-up contribution) may be contributed to your IRA. Your catch-up contribution can be up to $1,000 annually.
You can distribute your Traditional IRA assets at any time, subject to taxes and penalties. Assets distributed from a Traditional IRA generally are included in gross income in the tax year that they are received unless one of the following apply.
- Distribution is rolled over or transferred to an IRA or other eligible retirement plan
- Distribution of excess contributions removed before the tax return due date, including extensions (but the net interest attributable to the excess is includable in gross income)
- Transfers or rollovers incident to divorce
- Distribution of nondeductible IRA contributions
Taxable distributions from a Traditional IRA are taxed as ordinary income.
10 Percent Early Distribution Penalty Tax
If a distribution is taken from your IRA before the day you attain age 59½, the distribution is included in your gross income and a 10 percent early distribution penalty tax applies. This penalty tax generally does not apply if a distribution is taken because of one of the following reasons.
- Rollover to another IRA or an eligible retirement plan
- Qualifying medical expenses
- Health insurance premiums for unemployed individuals
- First-time homebuyer expenses
- Qualified higher education expenses
- Substantially equal periodic payments
- IRS levy
- Qualified reservist distributions
Required Minimum Distributions
You are required to take distributions from your Traditional IRAs beginning the year you attain age 72. If you fail to take a required minimum distribution (RMD), you must pay a 50 percent excess accumulation penalty tax on the amount of the RMD that was not distributed. IRA distributions must begin by your required beginning date for RMDs, which is April 1 of the year following the year you attain age 72. Distributions for each subsequent year must be taken by December 31 of that year.
You can take
- the required amount or
- any amount greater than the required amount.
For more information about RMDs, see a tax advisor.
The taxation of a Roth IRA distribution depends on what assets are being distributed and whether the distribution is considered qualified or nonqualified.
A distribution from a Roth IRA may be taken tax-free and penalty-free if it is a qualified distribution. A qualified distribution is one that satisfies a five-year waiting period, beginning with the year for which you first contributed to a Roth IRA, and one of the following events occurs.
- Attainment of age 59½
- First-time homebuyer
If a distribution from a Roth IRA is not qualified, taxes and penalties may apply. To determine the taxation, you'll need to understand the ordering rules for a Roth IRA distribution.
Ordering Rules for Distributions
The ordering rules state that if a Roth IRA owner has made both contributions and conversion or retirement plan rollover contributions to Roth IRAs, the assets are distributed in the following order.
Second: Conversions and retirement plan rollovers (by year)
Contributions and conversion/plan rollovers are not subject to tax when distributed. In some circumstances, however, distributed conversion/plan rollover assets might be subject to the 10 percent early distribution penalty tax. Earnings are taxable and subject to the penalty tax in a nonqualified distribution. But if the distribution is qualified, none of the distributed assets are taxable.
It is your responsibility as a Roth IRA owner to determine the taxation of your Roth IRA distributions by filing IRS Form 8606, Nondeductible IRAs,with your income tax return.
Roth IRA owners are not required to take distributions (RMDs) from their Roth IRAs. Beneficiaries of Roth IRAs, however, generally are required to take distributions. Spouse beneficiaries may treat the inherited Roth IRA assets as their own, and if doing so, are not required to take distributions.