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February 16, 2009

Roth IRA Conversion

Your Guide

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Definition

The converting of assets from a Traditional, SEP or SIMPLE IRA to a Roth IRA. Roth conversions can be accomplished in the following ways:

  • Converting the Traditional, SEP or SIMPLE  IRA to a Roth IRA. Very few custodians use this option.
  • Effecting a movement of assets directly from the Traditional, SEP or SIMPLE IRA to the Roth IRA. Under this option, the assets are made payable to the Roth IRA custodian. In most cases, the conversion occurs between IRAs held by  the same custodian. This transaction is referred to as a direct conversion.
  • The IRA owner taking a distribution from his/her Traditional, SEP or SIMPLE IRA, and rolling over the amount to his/her Roth IRA within 60-days. This transaction is referred to an indirect conversion.

For an indirect conversion, the rollover should be treated as a ‘Roth conversion’ and not as a regular rollover, so that it is reported correctly to the IRS and the IRA owner.

Effective January 1,2008 , Roth conversions are permitted from qualified plans, 457(b) and 403(b) plans to Roth IRAs. Prior to this date, the assets had to be first rolled to a Traditional IRA or SEP IRA before being converted to a Roth IRA.

A Roth conversion is treated as ordinary income to the IRA owner. Therefore, except for amounts attributable to after-tax rollovers or nondeductible contributions, the conversion will be taxable.

A Roth conversion is treated as a conversion for the year that the assets leave the non-Roth IRA. For instance, if an individual withdrawals amounts from a traditional IRA in December, and deposits the amount to a Roth IRA in January, the conversion is considered to have been done in December and is taxable for that year.

Referring Cite

IRC §408A, IRS Publication 590

Additional Helpful Information

  • Individuals are eligible to convert to a Roth IRA, only if they meet the following requirements:
    1. The individual’s adjusted gross income for the taxable year does not exceed $100,000; or
    2. The individual’s tax filing status is not ‘married filing separately’ IRC §408A(c)(3)(B)

However, this restriction was repealed under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) effective for tax years beginning January 1, 2010.

  • Roth IRA conversions are not subject to the 10 percent early distribution penalty which applies to distributions that occur before the IRA owner reaches age 59 ½ [IRC §408A(d)(3)(A)(ii)]
  • A Roth conversion can be nullified (made void) VIA a recharacterization
  • Effective January 1, 2005, the amount of any required minimum distribution (RMD) amounts from a Traditional IRA, SIMPLE IRA, or SEP IRA is not included in MAGI for purposes of determining the $100,000 limit for conversion eligibility (IRC Sec. 408A(c)(3)(C)(i))(II) and Treasury Regulation 1.408A-3, Q&A 6). The regulations do not address RMD from a qualified plan, 403(b) or 457 plans. As such, it appears that RMD from these plans are not excluded from the individuals MAGI when determining the $100,000 limit.

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at http://irapublications.com. Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.

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