Even if you're not working, you can open a Roth IRA account. Although you can't make a direct contribution to a Roth without earned income, you can convert a traditional IRA, 401(k) or similar retirement account into a Roth. If you're already retired, or if you're temporarily unemployed or experiencing a substantial short-term drop in income, now might be a good time to convert some retirement assets into a Roth. However, before you make such a move, make sure the consequences prove beneficial to your retirement strategy or estate plan.
Contribution Rules for a Roth IRA
You can make contributions to a Roth IRA only with compensation income, which includes earnings from an employer, self-employment income and alimony. So if you haven't worked all year, you probably won't be able to open a Roth IRA with a regular contribution, regardless of your total modified adjusted gross income through other sources, such as interest, dividends and capital gains.
Retirement Account Conversion Eligibility
Anyone can convert a Traditional IRA or 401(k) account fully or partially to a Roth account. You do not have to be eligible for a regular contribution to open a Roth IRA through a conversion.
Making a conversion to a Roth will not affect your eligibility to make regular Roth contributions. In addition, there are no income or earnings restrictions for contributions to a traditional IRA, so you can contribute to a traditional IRA and immediately convert it to a Roth IRA.
Conversion Tax Consequences
You must pay taxes at your ordinary rate for any amount that you convert. You do not pay taxes on any non-deductible contributions you have made, but you don't have the option of converting non-deductible contributions first or exclusively. The conversion must be in proportion to the taxable and nontaxable assets in all your traditional IRA accounts.
Matters Pertaining to Distributions
Another reason to own a Roth: No required minimum distributions. You must begin taking required minimum distributions from a Traditional IRA or a 401(k) on April 1 of the year after you turn 72. You never have to take a distribution from a Roth.
You can withdraw regular contributions tax-free at any time, and you can withdraw converted amounts tax-free immediately if you're over 59½. But if you're under 59½, you'll pay a 10 percent early-withdrawal penalty if you withdraw converted amounts before Jan. 1 of the fifth year after your conversion. Tax-free distributions on your earnings can begin only five years after you've opened the Roth account and you are 59½ or qualify for a distribution because you are disabled.
Are There Age Limitations?
You can continue contributing to a Roth – or converting into your Roth account – until you die. Continuing to convert assets in your traditional IRA or your 401(k) also will reduce the size of your required minimum distribution.
Favorable Tax Status for Beneficiaries
Converting a tax-deferred account to a Roth provides your beneficiaries with favorable tax status. Your beneficiaries will pay taxes at their ordinary tax rates on distributions from tax-deferred accounts, but the withdrawals can be made tax-free from a Roth. In addition, any required minimum distributions you avoid will allow you to leave more assets in your tax-free account.
Dale Bye has spent more than 40 years in journalism, including 25 supervising reporters and editors at metropolitan newspapers and eight years as senior managing editor at a national sports magazine. He directed five newspaper-sponsored personal finance fairs. His fields of expertise include business and personal finance, sports, fitness and theater. Bye holds a Bachelor of Journalism from the University of Missouri.