There are various types of individual retirement accounts (IRAs), to help people save money for retirement. One of the more popular of these is a Roth IRA, which will provide tax-free payouts of the money once the account holder reaches retirement age. Since this includes not only the money that was originally taxed but also any earnings, moving money from a regular IRA to a Roth IRA has appeal for many people.
There are different kinds of IRAs that can be classed as regular IRAs, including the traditional IRA, SIMPLE IRA and SEP IRA. Although there are differences between these different type of IRAs, one thing that they all have in common is that the money placed in them is tax-sheltered, meaning it is contributed before taxes are paid. This has the effect of reducing the account owner’s tax liability for the year, but taxes become due when the money is distributed, normally after the account owner’s retirement.
An essential difference between the Roth IRA and the other types of IRAs is that contributions to the Roth IRA are taxed prior to being placed in the account. This means that all money placed in a Roth IRA is after-tax money and can later be withdrawn without additional taxes being due. This is true not only for the contributions, but also for any money earned by the account during its lifetime. A person with a Roth IRA will not need to worry about how much other income he has at the time the money is distributed from the account nor what the tax rate is at the time he gets his money.
When money is transferred from a regular IRA into a Roth IRA, the IRS requires that it must be considered part of the account owner’s income at the time of the transfer. This means that she must report the regular IRA funds as income for the year in which the money was removed from the account, even though it was placed directly into another retirement account. This is reported at tax time on Form 8606, which must accompany Form 1040.
There are some important considerations when moving funds from a traditional type of IRA to a Roth IRA. If the account holder chooses to take a check and place it into a Roth IRA himself, the IRS mandates a 20 percent withholding for income taxes. If he is also less than 59 1/2 years old, another 10 percent will be withheld to cover the early withdrawal tax penalty. To simplify the transfer and avoid withholding, the transfer must be done directly between the account trustees. This moves all of the money into the Roth IRA and no penalty will be assessed, though taxes will still be due on the moved funds.
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