Converting a traditional individual retirement account (IRA) to a Roth IRA can help you save more money for retirement and relieve you of the burden of taxes on the money when you use it in retirement. The federal government taxes the conversion, but you can spread the bill out to ease the pain.
Traditional vs. Roth IRA
The main difference between a traditional IRA and a Roth IRA is when you pay the taxes. With a traditional IRA, you pay taxes on the money when you withdraw it, but with a Roth IRA, you pay taxes when you deposit money. Roth IRAs also provide more flexible early access to the money and a longer growth period.
In 2010, the Internal Revenue Service adopted new rules regarding traditional to Roth IRA conversions. Prior to 2010, you could not covert an IRA if your annual adjusted gross income was more than $100,000. However, conversion is now available to those of all income levels.
Taxes on the Conversion
You'll have to pay taxes on the amount converted. If you withdraw money from the account to pay the taxes on it, you'll also have to pay taxes on those funds. Your best option is to pay the taxes on the conversion with unrelated monies. This means rejecting withholding when its offered when you enact the conversion with your fund administrator.
Spliting the Tax Bill
You cannot apply your conversion to the previous year you made the conversion, but you can split the tax bill up between two years. You can pay part of the taxes on the conversion the year you enact it and the remainder the following year, generally divided into equal amounts.
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