Roth IRAs -- also known as Roth individual retirement accounts -- provide certain tax provisions that allow investors to accumulate interest earnings on a tax-free basis. Traditional IRAs -- another type of retirement plan account -- include certain requirements for taxing contributions and interest earnings. Because of the tax-free provisions available through Roth IRAs, certain rules apply when converting a traditional IRA to a Roth IRA.
Individual Retirement Accounts
Individual retirement accounts (IRAs) provide a means for saving for retirement and also function as a type of investment vehicle. Traditional IRAs and Roth IRAs exist as two different types of retirement accounts, each with its own positives and negatives. Contributions made to a Roth IRA come from after-tax dollars, whereas before-tax or after-tax dollars can fund a traditional IRA account. Whether or not a person has to pay taxes upon withdrawal depends on the type of contributions made to the account. Since Roth IRAs contain after-tax dollars, a person can withdraw contributions from an account at anytime on a tax-free basis. Traditional IRAs work a little differently; especially those funded with before-tax dollars. As a result, certain tax rules apply in cases where a person transfers money from a traditional IRA to a Roth IRA.
Tax Law Changes
Roth IRA conversions involve rolling over money from another type of investment account, such as a traditional IRA or 401k. Any Roth IRA conversions done as of the time of publication have a same-year tax requirement, meaning any taxes due must be paid in the year when the conversion took place. Another tax law change concerns the limits on the amount of money a person can make in order to do a Roth IRA conversion. According to RothIRA.com, an investment resource site, anyone making above $100,000 a year cannot open up a Roth account; however, changes in tax law do allow high-income earners to convert an existing IRA account into a Roth IRA.
Tax Deductible Contributions
Anytime money transfers occur between a before-tax account IRA and an after-tax IRA account, federal tax rules apply. This requirement makes up for the tax deduction accountholders can claim when using before-tax dollars to fund a traditional-IRA account. Rules regarding transfers from before-tax, traditional IRA accounts to Roth IRAs require accountholders to pay taxes on the amount transferred since before-tax dollars funded the traditional IRA account. In effect, the entire amount of money in a before-tax traditional IRA account becomes taxable.
Non-Tax Deductible Contributions
People who opt to fund a traditional IRA account with after-tax dollars cannot claim a tax deduction on monies in the account since taxes have been taken out beforehand. As a result, rules for transferring money from a non-tax deductible, traditional IRA account to a Roth IRA do not impose taxes on the entire amount transferred. The amount taxed corresponds with any earnings amounts made on the account. In other words, after-tax contribution amounts transfer tax-free. Anything over and above the contribution amount becomes taxable.
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