Traditional vs. Roth IRAs

When considering switching, a number of things should be kept in mind. Contributions to traditional IRAs may be tax deductible and accumulate tax deferred until funds are withdrawn, usually during retirement. Distributions from traditional IRAs are taxed as ordinary income and, if taken prior to reaching age 59½, may be subject to an additional 10 percent federal income tax penalty. Contributions to Roth IRAs are made with after-tax dollars, but qualified withdrawals (usually during retirement) are free of federal tax.

To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.

General IRA Conversion Information

When you convert a traditional IRA to a Roth IRA, you must pay income taxes on the amount converted (in the year converted). In addition, if you are under age 59½, any funds withdrawn from the account to pay taxes will likely be subject to an additional 10 percent federal income tax penalty. A Roth IRA must be in place for at least five tax years before qualified withdrawals become tax exempt.

If you expect to be in a higher tax bracket during retirement, converting to a Roth IRA before you retire may help reduce your overall tax burden. There are no mandatory withdrawals from Roth IRAs, so if you’d like to preserve more of it for your heirs, a Roth conversion may be wise.

Although there are distinct advantages to tax-free earnings, Roth IRAs are not for everyone. Your financial outlook and investment goals will help determine whether a conversion may be right for you.