Convert to a Roth IRA

What to do if you want to convert to a Roth IRA, but can't.

Elizabeth Carlassare
4-minute read
Episode #28


Today’s topic is what to do if you want to convert to a Roth IRA, but can't. 

A Roth IRA is a great way to save for retirement if you’re eligible to contribute. With a Roth IRA, you contribute after-tax money, but your earnings get to grow free of federal tax. And, you pay no federal tax on distributions if you’ve had the Roth for five years or longer and are at least age 59 1/2.

Why to Invest in a Roth IRA

Because a Roth provides retirement income that’s free of federal tax, it’s a smart way to invest for retirement. If you’re single, your modified adjusted gross income must be under $99,000 to contribute to a Roth in 2007. If it’s between $99,000 and $114,000, you can make a partial contribution.

 And if you’re married filing jointly, you can contribute to a Roth if your modified adjusted gross income is less than $156,000. For incomes between $156,000 and $166,000, you can make a partial contribution as well.

So how do you decide if a Roth is right for you? If you’re younger or think your tax rate will be the same or higher when you retire than it is today, a Roth is likely to be your best bet. You have to pay tax on your contributions today, but your earnings grow tax free, which can really help increase the future value of your retirement investments.

Converting to a Roth IRA

If you’ve been contributing to another type of IRA or have rolled over your 401(k) from a previous employer into a rollover IRA, it’s possible to convert it to a Roth IRA. But if you convert to a Roth, you’ll need to add the taxable amount you’re converting to your income on your tax return and pay income tax on it, which can mean a bigger than usual tax bill. After you’ve paid the tax, though, the pain is over and your earnings will grow tax free.

If you’re thinking of converting to a Roth, be sure to estimate the tax bill first. If it’s more than you’re prepared to pay, you can consider converting just a portion of your existing IRA to a Roth to keep the tax bill manageable. To avoid penalties, don’t pay the tax bill with IRA money. It’s best to pay the taxes with money outside your IRA. I have a handy Quick Tip about how Roth IRA conversions are taxed, so be sure to check it out.

Are You Eligible for a Roth Conversion?

Not everyone is eligible to convert to a Roth. To be eligible, your modified adjusted gross income whether you're single or married filing jointly must be $100,000 or less. Because of this income restriction, many married couples with two incomes and single high-income earners are not eligible to convert to a Roth.

If this describes you, listen up because the situation is actually going to change for the better: In 2006, a new tax law was introduced that allows anyone to convert existing IRA assets to a Roth in the year 2010. So if you want to convert but haven’t done so because of the income cutoff, you’ll be able to convert in 2010!

The new law also lessens the tax pain of converting to a Roth. Instead of having to pay federal tax on the taxable conversion amount all in one year, you’ll be able to spread the tax bill over two years. If you convert to a Roth in 2010, you can pay half the tax in 2011 and the other half in 2012.

So if you want to convert all or some of a traditional, rollover, or SEP IRA to a Roth, but haven’t been eligible, plan ahead and mark your calendar for 2010!

For up-to-date information about Roth IRAs, please refer to episode 173 about the difference between Traditional and Roth IRAs, and episode 154 about the new Roth rules for 2010.

As always, everyone’s situation is different, so be sure to consult a tax or financial advisor before making important financial decisions. This podcast is for educational purposes only and is not intended to be a substitute for seeking personalized, professional advice.

Today, I’m giving away two copies of The Wealthy Barber by David Chilton. This book is a quick and simple read that explains how to manage your finances and achieve wealth over time. This week’s winners are Beth T. and Tim C. Congratulations! Check your e-mail for instructions and enjoy the book!

Cha-ching! That’s all for now, courtesy of Money Girl, your guide to a richer life.

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Related links:

o      Roth IRA   
o      Tax Increase Prevention and Reconciliation Act of 2005       

o      More on the Act

o      Roth vs. Traditional IRA Calculator

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