How to Transfer Mutual Funds to a Roth IRA

A Roth IRA is a popular investment tool for many who are saving for retirement. According to the IRS, you can withdraw the money and earnings tax-free during retirement because it was funded with after-tax dollars. The IRS has strict rules about how you can fund and maintain your Roth IRA. One of the more common questions is whether you can fund your Roth IRA with a mutual fund.

You need to be aware of a few key differences when you compare an IRA vs. a mutual fund. A mutual fund is a pool of money from different people that is used to buy stocks, bonds, and other types of assets. Mutual funds allow individuals to invest in instruments and spread the risk over a larger pool of stocks. They are managed by the fund manager, who has the authority to buy and sell stocks on behalf of the investors.

A Roth IRA is a type of account that is specifically set up as a retirement account. Roth IRAs have specific rules when it comes to what can be used to fund them and when you can begin withdrawing from them without penalty. You'll need to have earned money to contribute and pay taxes at that time. Therefore, you typically can't put money in one if you just had unearned income.

The IRS offers a lot of information about conversions, and it only allows transfers into a Roth IRA from another qualified retirement account. If you have a mutual fund as part of a qualified retirement account, then you might be allowed to roll over that retirement account to your Roth IRA. You will owe taxes on any distributions from that retirement account for the Roth conversion.

If the mutual fund isn't in a qualified retirement account, you could opt to sell it and then use the proceeds as a cash contribution to your Roth IRA after you have paid taxes on it. However, the best mutual funds for Roth IRA conversions are those that are in a qualified retirement account since you can simply take advantage of rollover options

Many factors determine how mutual fund distributions are taxed and how much you would have to pay if you wanted to place the money received in a Roth IRA. The amount of tax you owe depends on how long you have held the asset.

For instance, assets held for more than one year will be subject to capital gains tax. If you have held the funds for a year or less, they are considered short-term gains and will be treated as ordinary income taxes. The category under which the funds fall determines the percentage you owe the IRS.

There are exceptions to this rule. For instance, qualified dividends are taxed as long-term capital gains, but nonqualified dividends are taxed at normal income rates. Some bonds might be exempt from taxes.

The types of securities held in the fund determine how distributions are taxed. You can find information on the fund’s distribution policy in its prospectus. For instance, equity and bonds funds might be treated as capital gains, but a growth fund might be treated as an income dividend.

When setting up and contributing to a Roth IRA, it is important to understand the rules for what can be used as contributions. The IRS website is the best source of information on Roth IRAs, distributions, and how they are treated. You can always ask your financial adviser to see how the rules apply to your particular situation.