Pros & Cons of Converting a Tradtional IRA to a Roth IRA

If you have a traditional Individual Retirement Account, you may wonder if you would gain a financial advantage by converting it to a Roth IRA. In many cases, the answer is yes. However, there are both pros and cons to converting a traditional IRA to a Roth IRA. The ultimate decision depends largely on your personal or family circumstances.

Pre-Tax versus After-Tax Contributions

Many of the major distinctions between a traditional IRA and a Roth IRA concern income tax liability of contributions. If you do not have access to a retirement fund program at work, you are probably eligible for a deductible traditional IRA. The Internal Revenue Service allows you to deduct contributions to a traditional deductible IRA from your adjusted gross income, up to the annual limit. You don't have to pay federal income taxes on a traditional IRA until after you start receiving distributions, usually after you've retired. By contrast, Roth IRAs are funded with after-tax dollars, that is, the IRS does not allow you to deduct contributions to a Roth IRA from your adjusted gross income. If you roll over your traditional IRA into a Roth IRA before age 59 1/2, the IRS also imposes federal income tax on the conversion.

Tax Liability for Distributions

With most traditional IRAs, the IRS imposes federal income taxes once you begin receiving distributions. However, in many instances, your total income is lower than when you made the contributions to the IRA, which translates to a lower tax rate. With Roth IRAs, as long as you are at least 59 1/2 years old when you begin receiving distributions, those distributions are tax-free.

Mandatory Distributions

You must begin taking distributions from a traditional IRA no later than age 70 1/2. The IRS also bars you from contributing to a traditional IRA after age 70 1/2, even if you are still working. On the other hand, the IRS does not impose mandatory distributions on a Roth IRA while you are alive. You may also continue to contribute to a Roth IRA as long as you earn qualified income. If you die and name your spouse as a beneficiary to your Roth IRA, your spouse may either wait until you would have been age 70 1/2 to begin receiving distributions, or take possession of the IRA outright.

Early Withdrawals

If you make a withdrawal from a traditional IRA before age 59 1/2, in most cases, you will be hit with a hefty 10 percent penalty. You can withdraw your contributions from a Roth IRA any time, but you must wait five years before you can withdraw money from rolling over a traditional IRA. If you make withdrawals against the interest your Roth IRA has earned before age 59 1/2, you may be subject to a 10 percent early withdrawal penalty. However, if you're paying expenses associated with a sudden disability, covering medical expenses greater than 7.5 percent of your adjusted gross income or paying tuition for yourself, your spouse or your kids, the penalty does not apply. You can also apply up to $10,000 in earnings from a Roth IRA toward the purchase of your first home without penalty.