The Tax Implications of Rollover Roth Contributions
- You can convert your traditional IRA to a Roth IRA by contacting your IRA custodian and requesting a transfer request form to convert a traditional IRA to a Roth IRA. Some financial institutions refer to this form as a Roth conversion form. The financial institution you are working with will help you fill this form out. When you convert your traditional IRA to a Roth IRA, you must pay income taxes on all of the money in the traditional account. This is because none of the money in the traditional IRA has been taxed yet.
- When you make future contributions to the account, you may only make after-tax contributions. This limits your ability to reduce your current income when compared to making traditional IRA contributions. However, you receive all of the money from the Roth IRA income tax-free when you reach age 59 1/2 as long as you've kept the account open for at least five years.
- Your conversion to a Roth IRA may increase your total tax liability in the year you do the conversion. This is because all of the conversion amount is added to your income and the money is taxed as ordinary income. If the conversion is significant, it will put you into a higher tax bracket, causing your average tax rate to increase. This, in turn, increases the taxes you pay on your conversion amount.
- You can convert your Roth IRA over time, thus lowering the tax bite in any given year. However, before you convert to a Roth and start making after-tax contributions, analyze the benefits of the Roth versus the traditional IRA. If your tax rate remains the same when you retire as it did when you were working, then you will have just as much money, possibly more, with the traditional IRA. Roth IRAs only benefit you when your tax rate increases after retirement.