This piece will explore the basics of a Roth IRA conversion, including defining what it is, who is eligible and why one may want to do a conversion – or not. In further articles we will delve more deeply into some of these aspects.
There are two basic types of Individual Retirement Accounts (IRA). The first is what is called a traditional IRA. As long as the account follows all of the rules of an IRA, all income in the IRA stays in the IRA tax-deferred until such time as it is withdrawn. Withdrawals are taxed as ordinary income. Early withdrawals – before age 59.5, and without meeting certain exceptions – are penalized at 10%. Additionally, traditional IRA contributions are generally tax deductible. If the IRA contribution is not tax-deductible, it creates what is called basis in the IRA. That basis can come out of the IRA, pro-rata with other funds, tax- free. The younger brother to the traditional IRA is the Roth IRA. Created in 1997, the Roth IRA is a tax-free retirement account. Taxpayers get no deduction for Roth contributions, although low-income individuals may qualify for a small tax credit. Roth funds can grow tax-free until withdrawn. Penalties still apply for withdrawals before age 59.5, and there is an additional requirement that the individual have a Roth IRA open for at least five years to withdraw earnings penalty-free. Oddly, it does not need to be the same account. As long as the owner has had any Roth IRA open for five years, that requirement is met. Further, contributions can be withdrawn tax and penalty free at any time. Roth IRAs have become quite popular. Recently, employer plans, such as a 401(k) have also started offering Roth accounts.
Finish reading here: Roth IRA Convesrion highlights.pdf