Converting a traditional IRA
to a Roth IRA can offer powerful benefits, but it requires consideration of several factors.
The bankruptcy court relied on what it said was the plain language of Section 522(b)(3)(C) of the Bankruptcy Code and concluded that an inherited IRA "does not contain anyone's 'retirement funds,'" because unlike a traditional IRA
, the funds in an inherited IRA "are not segregated to meet the needs of, nor distributed on the occasion of, any person's retirement" (id.
Additionally, average contributions to Roth IRAs continue to outpace average Traditional IRA
contributions on both ends of the age spectrum.
Jameson Van Houten and Stonegate Financial Group present the advantages of a Roth IRA over a traditional IRA
and discuss how individuals who earn high incomes can now take advantage of them.
But remember that if the $5,500 had gone directly into a traditional IRA
, you would have reaped about $1,375 in tax savings each year at a 25 percent tax rate (more, with a higher tax rate).
At the time, I suggested converting their traditional IRA
, which held $3 million in assets, to a Roth IRA.
If your client qualifies for this exception, is under age 59-and-a-half, and looking to roll over his or her 401(k) account to a Traditional IRA
, you need to question the advisability of transferring the entire balance.
With a traditional IRA
, contributions may be tax-deductible, earnings are tax-deferred, and there are no income limits for contributions.
Before looking at the issues specific to recharacterizations, the following will summarize the basic rules governing the federal income taxation of converting a traditional IRA
account to a Roth IRA.
In a traditional IRA
, you contribute money pre-tax each year (to a $5,000 or $6,000 annual max depending on your age), and then when you withdraw that money in retirement, it is considered income and taxed as such.
Additionally, there is an upfront tax that has to be paid on any money that hasn't already been taxed when electing to convert a traditional IRA
to a Roth IRA.
The traditional IRA
allows you to sock money away and get an immediate tax deduction.