Most of our clients have a significant portion of their wealth in IRAs and company retirement plans. There may be a benefit to moving money among different plans, each of which involves its own set of costs and benefits. However, good pre-move tax planning is essential here as there are many tax traps waiting for the ill advised.
One such opportunity is the “Roth conversion.” If you have a traditional IRA (one in which you got a deduction each time you made a contribution to the account), distributions from the account (presumably during your retirement) will be treated as taxable income. Distributions from a Roth IRA are tax-free. In addition, there are no back end required minimum distributions as there are with traditional IRA’s.
You may convert all or a portion of a traditional IRA to a Roth IRA and make future distributions tax-free, but there is a cost: the amount of the conversion is taxable income in the year of the conversion. It is good planning to make conversions when income is down, and you can report the income from the conversion in a lower tax bracket. It is also a good idea to consider these in today’s current low tax environment that could change with a new administration.
You can roll funds over from a traditional IRA to a Roth IRA regardless of your AGI (unlike in years before 2010). The 10% early withdrawal penalty will not apply to the rollover. However, if rolled over funds are withdrawn within the five-year period that renders them taxable, the 10% penalty will apply to the withdrawal.
A conversion from a traditional IRA to a Roth IRA is not subject to the one-rollover-per-year rule and is disregarded in applying limitation to other rollovers.
Conversions don’t work for everyone. If you are getting close to retirement age and are in a high tax bracket you may not want to do a conversion. Planning is key, so call or office for an appointment if you would like to discuss retirement plan options.