Converting a traditional Individual Retirement Agreement (IRA) into a Roth IRA is an appealing option for individuals who believe that their retirement income will be taxed at a higher rate than their current income. Traditional IRAs are taxed at ordinary income tax rates when funds are withdrawn from the account while Roth IRAs are taxed now, but withdrawals are usually tax-free. Knowing whether information you heard is a myth or reality can help you decide whether the traditional or the Roth is better for you.
Roth IRA Contributions Can't Be Deducted Before Age 59 1/2
Although Roth IRA earnings cannot be deducted before you reach the age of 59 1/2 without penalty, your contributions can be deducted at any time without having to pay any additional taxes or penalties.
It Takes Years for a Conversion to Pay Off
Converting a traditional IRA into a Roth IRA does not come free: Traditional IRAs have not been taxed so by converting funds, you must pay taxes on the contributions going into the Roth IRA. If you're close to retirement age, your higher up-front tax bill may not be worth making the conversion.
Converting Is Permanent
After you convert during one tax year, you have until October of the following tax year to unconvert the funds. You may choose to do this in order to avoid having to pay the additional taxes that are associated with converting untaxed dollars into taxed dollars or if your investments decreased in value.
The Entire IRA Must Be Converted
You can convert only a portion of the assets in a traditional IRA if you prefer. Making gradual conversions can help you minimize the additional amount of taxes that you must pay for the transaction.
Converting Pushes Me Into a Higher Tax Bracket
The amount of your IRA that you convert into a Roth IRA is considered taxable income. An increase in taxable income can push you toward a higher tax bracket. However, if you convert funds over a few years, you can minimize the impact of your conversion so that your income only slightly increases for a few years.
You Can't Access Funds for Five Years
You can access money that you contributed to the IRA at any time. You can also access your earnings on the IRA, but you may be subject to paying a 10% penalty. However, if the account has been open for five years or you are over 59 1/2, you can avoid any additional taxes.
Roth IRAs Can Prevent Your Child From Getting Financial Aid
A parent's taxable income can impact the financial aid that is offered to his child for college. However, you can inform your child's school of the conversion so that school officials do not believe that you have a higher level of income than you really do.
Samantha Kemp is a lawyer for a general practice firm. She has been writing professionally since 2009. Her articles focus on legal issues, personal finance, business and education. Kemp acquired her JD from the University of Arkansas School of Law. She also has degrees in economics and business and teaching.