IRA Rollover

Archive for July, 2008

Question: When converting a Rollover IRA to a ROTH IRA?

do you have to stay under the $4000 allowable contribution for the year or can you rollover the entire amount into the ROTH. Can you then contribute the additional $4000 on top of the Rollover in the same year?

Thanks for your experience, in advance.
ex: Can I take all 20k from a rollover IRA and out it into a ROTH. Then, in the same year, can I contribute the $4,000 allowable contribution?

Answer: When you convert any tax-deferred IRA to a Roth, whether it’s a rollover or not, you have to report all of the converted funds as ordinary income and pay the income tax. The yearly allowable contributions have nothing to do with this. If you are younger than 59 1/2 when you do the conversion, any part of the converted amount that you do not put into the Roth will be susceptible to the 10% early withdrawal penalty.

Example. Your IRA is worth 50K and you are in the 25% tax bracket. You are going to have to pay $12,500 in tax on the 50K. If you do not have the cash to replace that $12,500, so that you can onlt afford to put $37.5 K in the Roth and keep the rest to pay the tax, you will pay a 10% penalty on the $12,500.

Converting regular IRA accounts to Roth are usually not a good idea, unless the value of the existing IRA is small, or you expect your tax bracket in your retirement years to be the same as in your working years. In that case, a Roth may be better in the long run, since you pay no tax on anything in it.

Just saw the 20K figure. If that is the total value of your tax-deferred IRA, your tax hit won’t be that severe. If you’re in the 25% bracket, you’ll owe 5K in tax. If you have the 4K to contribute to a Roth (more about that later), use it to replace what you’re losing in taxes and add the other thousand as well, to put the entire 20K into the Roth and avoid the early withdrawal penalty. The lifetime tax-free benefits of the Roth should more than compensate for the 5K in taxes.

The conversion is one transaction. Contributions are separate transactions. If you have the money to pay any taxes owed, plus put the entire 20K into the Roth, and still contribute the 4K for the year, you can go ahead. Remember that you can contribute to your Roth for 2007 until April 15, 2008. If you have the money to do the 2008 contribution as well, the sooner the better. Get that money working tax free as soon as possible.

Roth IRAs in 2010 Part 6