Roth IRA Conversions

February 2, 2015 // Bucket Strategy Investing

With the lure of tax-free distributions, Roth IRAs have become increasingly popular retirement savings vehicles. According to the Investment Company Institute, 19.1 million U.S. households (about 15.6%) owned Roth IRAs in 2013.

There are three ways to fund a Roth: you can contribute directly, you can convert all or part of a traditional IRA to a Roth IRA, or you can roll over funds from an eligible employer retirement plan. Generally speaking, you can contribute up to $5,500 to an IRA (traditional, Roth, or a combination of both) in 2015 ($6,500 if you’ll be age 50 or older by December 31). However, your ability to make annual contributions may be limited (or eliminated) if your income level is above certain thresholds. Also, unlike with a traditional IRA, you can contribute to a Roth IRA even if you’re age 70½ or older. But keep in mind that must be working and your contributions generally can’t exceed your earned income for the year.

The rules for conversions have changed a bit since 2010. Prior to that, you couldn’t convert a traditional IRA to a Roth IRA if your MAGI (modified adjusted gross income) exceeded $100,000. But because of the change in 2010, you can now convert a traditional IRA to a Roth IRA regardless of your filing status or how much you earn (with one exception—you can’t convert an inherited IRA to a Roth. Special rules apply to spouse beneficiaries.)
Although you will pay ordinary income taxes on the amount you convert, the process of converting is relatively simple. You start by notifying your existing traditional IRA trustee or custodian that you want to convert all or part of your traditional IRA to a Roth IRA; the custodian/trustee will then provide you with the necessary paperwork.

You can also open a Roth IRA at a different financial institution and have the funds in your traditional IRA transferred directly to your new Roth IRA. If you prefer, you can instead contact the trustee/custodian of your traditional IRA to have its funds distributed to you, then roll those funds over to your new Roth IRA within 60 days of the distribution. The tax consequences are the same regardless of the method you choose. And a “conversion” rollover does not count towards the one conversion in 12-months rule.

The rules on distributions can be complicated. Distributions of your cumulative contributions are tax and penalty free. distributions of “converted” principal within five years of the conversion could be subject to a penalty if taken prior to age 59 ½ . And a distribution of earnings will be taxed at ordinary income rates. AND subject to a 10% penalty if withdrawn prior to age 59 ½ or within five years of the first tax year you created the ROTH.

Distributions of principal from a Roth IRA are tax-free however, any earnings will be taxed at ordinary income rates and a 10% penalty tax will apply if withdrawn prior to age 59 ½ or within five years of the date the Roth IRA was established, whichever is longer.

Information presented should not be considered specific tax, legal, or investment advice. You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal.

Investment advisor representatives of Lucia Wealth Services, a registered investment advisor, are also registered representatives of, and offer securities through, Lucia Securities, LLC, a registered broker/dealer, member FINRA/SIPC. Lucia Wealth Services and Lucia Securities, LLC are wholly owned subsidiaries of Lucia Capital Group.

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