AS ALWAYS, THERE ARE RULES
Like IRAs you roll over from one account to another, IRAs funded with retirement plan money are subject to some specific regulations. Following the rules postpones taxes and protects you from fees and penalties. And when you put money in an IRA, you assume more personal responsibility for keeping track of your investment.
A ROTH CONVERSION
One way to take advantage of the tax-free income a Roth IRA provides is to convert your current IRA to a Roth. You'll owe the tax due on your earnings (and on your investment amount if you deducted your contributions), but no penalty. You're also eligible to convert a tax-deferred 401(k) or similar plan to a Roth IRA after you retire or leave the plan.
There are no income caps limiting who is eligible to make a conversion. Even if you're not eligible to make an annual contribution to a Roth IRA, you can convert to a Roth IRA.
You'll probably want to get some expert advice on whether this strategy pays for you. The answer will depend on:
- How much you have to transfer
- Your current tax rate
- Your age
- The time until you plan to withdraw from the Roth
As with other Roth accounts, you must keep an account created with converted funds open for at least five years before you can take tax-free withdrawals. If you're not confident you can wait that long, it's probably not smart to transfer your funds,
pay the tax due, and then withdraw early, only to be faced with more taxes (and potentially a penalty).
Remember that married people who file separate tax returns are not eligible to roll over to a Roth. A tax adviser can help you decide whether you should file jointly for one year in order to move your IRA. Another thing to consider is that the tax on the amount you're moving is due in the year the IRA is moved. That could add up to a lot of money if your account balance is substantial. And it could bump you into a higher tax bracket, increasing what you owe even more. But if you have had significant losses in your IRA before you move it into a Roth, you may owe very little tax or none at all.