Rules for Roth IRA Conversions — Do Conversions Count Towards IRA Income Limits?

Roth IRAs can play a key role in zero-tax bracket retirement planning because withdrawals from Roth IRAs are not taxed. For some of our Michigan clients, converting traditional IRAs to Roth IRAs are a way to increase retirement savings because Roth conversions do not count toward the income thresholds for contributions. For individuals and couples who need to increase retirement savings quickly, a Roth conversion may help.

Below we discuss some of the rules for Roth IRAs and converting other retirement accounts to a Roth IRA.

Roth IRA Income Phase Outs for 2018

When the IRS announced the retirement plan contribution limits for 2018, we saw a slight increase in the phase out ranges for adjusted gross income (AGI) with regard to Roth IRAs. The new range for individuals and heads of households is $120,000 to $135,000. For married couples, the AGI range is $189,000 to $199,000.

There are two pieces of good news if you want to invest in Roth IRAs. The AGI range increase may now allow you to contribute to a Roth IRA if you previously earned too much money to be eligible to fund a Roth IRA. The second piece of good news is the restrictions for Roth IRA conversions were removed. Therefore, if you earn above the AGI limits, you may still invest in a Roth IRA by converting traditional retirement accounts to a Roth IRA. There are no income limits for conversion to Roth IRAs.

How Do I Convert a Traditional IRA to a Roth IRA?

There are three ways to transfer your current IRA to a Roth IRA:

  • Use the Same Financial Institution — You can set up a Roth IRA with the same financial institution that serves as the trustee for your current IRA and then direct it to move the funds from your traditional IRA to the new Roth IRA.
  • Use Another Financial Institution — If you do not want to use the same financial institution as the trustee for your Roth IRA, you can open an account with another financial institution. After opening the Roth IRA, you simply direct the trustee for your traditional account to transfer funds to the new Roth IRA.
  • 60-Day Rollover — If you withdraw the funds from your traditional IRA, you have up to 60 days from the date of the distribution to invest the funds into a Roth IRA. However, if you fail to roll over the funds before the deadline, you will be charged applicable taxes and the 10% early distribution penalty.

It is easier to transfer funds from one trustee to another trustee or to use the same financial institution. It is also safer because you do not need to worry about missing the deadline for rollovers. However, you will pay taxes on the conversion, less any contributions that were nondeductible contributions, in the tax year of the conversion. You will not be subject to the 10% early withdrawal penalty if the conversion is handled correctly.

Why Convert to a Roth IRA?

One of the main reasons a person converts a traditional IRA to a Roth IRA is to avoid paying income taxes on withdrawals during retirement. Other forms of retirement accounts use tax-deferred income to fund the account. Therefore, you receive a tax break now, but the IRS expects you to pay taxes when you withdraw the funds.

Roth IRAs are funded with after-tax dollars. Therefore, you do not pay taxes on the withdrawals from your Roth IRA during retirement.  Roth IRAs offer another huge benefit. Unlike the interest earned in a traditional IRA, the investment earnings in a Roth IRA are not subject to taxes. However, you must be at least 59 ½ years old when you begin withdrawing funds from the account, and you must have opened the account at least five years prior to the first withdrawal.

Another important benefit of Roth IRAs is the lack of a required minimum distribution (RMD) at age 70 ½. A Roth IRA does not require RMDs at any age. This difference can be very important for retirees who need to adjust retirement income for tax purposes. It can also help retirees continue to earn investment income during retirement to avoid outliving their retirement funds.

Consult a Michigan Retirement Planning Attorney

Deciding whether to convert retirement accounts to Roth IRAs can be a wise decision. However, there are many factors that must be considered before determining whether this is a good option for you. Before you begin converting or rolling over retirement funds from any account, you should consult an experienced retirement planning attorney.

Our Michigan estate planning and retirement planning attorneys can help you develop a plan that meets your goals and needs while protecting your family and assets. Call 888-390-4360 or use the contact form on our website to schedule a consultation with one of our attorneys.

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