What is a Roth IRA conversion?

A Roth Personal Retirement Account conversion occurs when an investor transfers funds from a traditional IRA to a Roth IRA. When an investor makes a Roth IRA conversion, the Internal Revenue Service requires the investor to pay ordinary income tax on the transferred funds. Best rollover ira accounts after conversion, the investor does not have to pay capital or earnings taxes in the Roth IRA, as long as the funds are not withdrawn within five years or before the investor reaches the age of 59 and a half.

People who access the funds of a Roth IRA or traditional IRA prematurely must pay a 10% tax penalty. The IRS allows taxpayers in it to set aside retirement money in IRA accounts. Funds within IRA accounts increase deferred taxes. Traditional IRAs are funded with pre-tax earnings and, as a result, both capital and earnings are fully taxable when the investor makes withdrawals. Withdrawals from the Roth IRA are not subject to taxation because the accounts are funded with after-tax earnings.

Investors can potentially reduce their tax burden by using a Roth IRA conversion to transfer traditional IRA funds already accumulated into non-taxable Roth accounts. The investor pays ordinary income tax at the time of conversion, but the account earnings are subsequently non-taxable. People who leave funds in a traditional IRA eventually have to pay taxes on capital and all future earnings.

The IRS only allows taxpayers who earn below certain thresholds to move funds from a traditional IRA using a Roth IRA conversion. The income limits for these operations are determined on an annual basis.