The Tax Increase Prevention and Reconciliation Act of 2005 effectively removed two requirements stopping many taxpayers from completing the IRA conversion process: Adjusted Gross Income (AGI) exceeding $100,000 and taxpayer filing status of married but filing separate from the spouse. With these requirements gone, any taxpayers with a traditional IRA can easily convert them into a Roth IRA. Doing so allows the taxpayer to pay taxes on retirement income up front instead of at distribution.
Converting Traditional to Roth
Investors can convert a traditional IRA into a Roth IRA regardless of their amount of income. Unlike traditional IRA's, Roth IRA contributions are taxable when they are made and non-taxable when the money is distributed. Conversion of a traditional IRA into a Roth IRA makes the funds taxable. Tax laws for the 2010 income tax filing season allow the new income from the conversion to be taken over the course of two years instead of one year. The conversion amount is spread equally between the years 2011 and 2012.
The taxpayer can convert all or a portion of the traditional IRA into a Roth IRA. The conversion amount must be reinvested in the Roth IRA within 60 days of removing it from the traditional IRA. The amount withdrawn and then converted is referred to as a conversion contribution. When properly converted within the 60 day window, the conversion contribution is not subject to the additional 10 percent tax required on early distributions. Under existing distribution rules, amounts required for distribution from a traditional IRA cannot be used for an IRA conversion.
Although rollovers are not referred to as IRA conversions, the process can effectively convert funds from one type of IRA into another. Traditional IRAs can be rolled over into other traditional IRAs, SEP IRAs or into Roth IRAs but not SIMPLE IRAs. SIMPLE IRAs can be rolled into traditional, Roth, SIMPLE and SEP IRAs. SEP IRAs can be rolled into traditional, Roth and SEP IRAS but not SIMPLE IRAs. Roth IRAs cannot be rolled into any other IRA except a Roth IRA. Any amount rolled from another IRA into a Roth IRA must be included as income for the year the rollover occurs.
Review Laws Annually
It is important to review current tax laws or consult with a financial or tax adviser when converting IRAs. Tax laws can vary from year to year and what was acceptable in one year may not apply for the following year. For example, as of the time of publication, the ability to spread conversion income over a two year period of time is allowed only for IRA conversions taken in 2010.
- IRS.gov: Publication 590 Individual Retirement Accounts (IRAs)
- U.S. Government Printing Office: Public Law 109-222; Tax Increase
- Internal Revenue Service. "Traditional and Roth IRAs." Accessed March 17, 2020.
- Internal Revenue Service. "Topic No. 309: Roth IRA Contributions." Accessed March 17, 2020.
- Internal Revenue Service. "IRA FAQs - Rollovers and Roth Conversions." Accessed March 17, 2020.
- Internal Revenue Service. "Topic No. 413: Rollovers from Retirement Plans." Accessed March 17, 2020.
- Internal Revenue Service. "About Form 8606: Nondeductible IRAs." Accessed March 17, 2020.
Alex Burke holds a degree in environmental design and a Master of Arts in information management. She's worked as a licensed interior designer, artist, database administrator and nightclub manager. A perpetual student, Burke writes Web content on a variety of topics, including art, interior design, database design, culture, health and business.