Roth Conversion Ira

In 2010, the income limitations for a Roth IRA were lifted, so many people are choosing to do a Roth conversion from IRA. Basically, this means that they are converting their traditional IRA retirement accounts into Roth accounts, which allows people to pay taxes on the income from that traditional IRA now so they don’t have pay taxes on it after they retire. Financial experts say it’s always a good idea to have a good balance between tax-free income after retirement and other income that is taxable, but there are several things you should know before beginning the process of converting a traditional IRA to a Roth IRA.

Roth conversion IRA eligibility

Not everyone is eligible to convert their traditional IRA to a Roth, but the new rules that went into effect at the beginning of 2010 mean that a lot more people are eligible. For example, married couples who file taxes separately can now qualify for the conversion even if they didn’t live apart for the entire year. Also the $100,000 modified adjusted gross income limit that once existed for Roth conversions is now gone.

Benefits of a Roth conversion IRA

There are many reasons someone may choose to convert from a traditional IRA to a Roth IRA. Of course the most obvious one is the tax savings. Yes, they do have to pay taxes on the income from the traditional IRA now, but it’s better to pay taxes on that smaller amount instead of the larger amount they will have after retirement when the account has grown with interest.

Another benefit to converting happens only during the year 2010. People who chose to convert during the year 2010 can split the income they are claiming on their taxes by deferring some of it until 2011 and 2012. This deferment option gives taxpayers the ability to save money to pay their tax bill in the coming years. However, taxpayers should remember that they are splitting the income from the conversion into those years, which does not necessarily mean they are splitting the actual tax into those years. It’s true for some cases, but not all.

The Roth conversion IRA loophole

Although the income limitations for those contributing to a Roth IRA have been lifted, the limitations for how much taxpayers can put into their Roth are still in place. This means that those who have already maxed out their Roth IRA contributions can’t make any more payments for the rest of the year. However, there is one loophole that allows them to pay into a non-deductible IRA and then immediately convert it to a Roth IRA.

Tax traps with a Roth conversion IRA

The most important pitfall to watch out for is loss of financial aid for college students. Parents often forget that their income has a direct effect on their student’s financial aid eligibility, and colleges do see income from a traditional IRA as income, even if it’s being rolled over to a Roth.

Some taxpayers also will end up paying higher Medicare premiums or having their Social Security payments taxed if they do a conversion. Once again, this is due to the income spike from the conversion.