How to Convert to a Roth IRA

Can I Convert My Traditional IRA to a Roth IRA?

You can change your traditional IRA to a Roth IRA, and vice versa, depending on your tax needs. A simple adjustment in your IRA may have a large impact on your taxes when it's time to withdraw money.

Equity Trust provides more details about conversion, recharacterization, and reconversion below. As always, you can call 1-888-ETC-IRAS (382-4727) for further information.

Am I Eligible to Convert?

You may convert some or all of your existing traditional IRA assets to a Roth IRA—as long as your adjusted gross income (AGI) is $100,000 or less. A conversion requires you to include in current income the taxable assets you're converting, but the conversion enables you to avoid future federal taxes on any subsequent IRA earnings and withdrawals. This opportunity for tax-free growth and tax-free distributions can substantially increase the value of your retirement savings down the road.

Why Convert an IRA?

With a traditional IRA, if you think that your tax rate when you withdraw your money will be the same or higher than your current tax rate, it may make sense to pay the tax liability now in exchange for the opportunity for tax-free growth and future distributions. This opportunity can substantially increase the value of your retirement savings later.

While converting to a Roth IRA requires you to include in current income the taxable assets you're converting, it enables you to avoid future federal taxes on any subsequent IRA earnings and withdrawals. You'll only need to pay taxes only on the earnings on those contributions when you take a distribution or convert.

Taxes may also be due on any deductible or pre-tax contributions and earnings, which you must include in your current income.

The longer you expect your assets to remain in your Roth IRA, the more you can benefit from its tax-free growth potential.

What Are Tax Implications of Converting My IRA?

To allow as much money as possible to grow tax free, you should use your non-retirement savings to pay any applicable taxes on your IRA distribution. As long as you can pay the taxes from another source, you may benefit from a conversion. If you must use some of your IRA assets to pay the taxes, you may be subject to an early withdrawal penalty on those assets. The resulting "cost" of converting could outweigh the benefit of tax-free growth.

If you find that converting all of your existing traditional IRA assets to a Roth IRA presents too large a tax burden, consider converting just a portion. Any taxes withheld will increase your modified adjusted gross Income (AGI), and they could make you ineligible for the conversion.

Need additional information? Contact an Equity Trust self-directed IRA specialist at 1-888-ETC-IRAS.

What is Recharacterization?

Recharacterization lets you change your mind about the type of IRA to which you make your annual contribution. You can also recharacterize assets that you once converted to a Roth IRA back to a traditional IRA. You can recharacterize for any reason, not just due to an error or ineligibility.

So, whether you discover that your income exceeds the AGI limits for an annual Roth IRA contribution or you contribute to a traditional IRA and later decide that the Roth IRA is the more attractive choice, you have a way to fix the situation. You're allowed to recharacterize your annual IRA contribution in either direction—from a traditional IRA to a Roth IRA, or from a Roth IRA to a traditional IRA.

What is Reconversion?

A reconversion occurs when you recharacterize Roth IRA converted amounts back to a traditional IRA, and then convert these assets back to a Roth IRA again.

Reconversions have become a popular way to minimize the tax burden of converting. But you should be aware that, in February 1999, the IRS released regulations placing limits on reconversions.

You generally won't be permitted to minimize taxes by reconverting IRA assets within a taxable year, although reconversions in the next taxable year are permissible. You should consult a tax advisor to more fully understand the regulations surrounding reconversions.