Sorting out the differences between Roth, traditional IRA
My recent column about Roth IRA conversions unleashed a flood of (so far) more than 100 reader e-mails illustrating widespread confusion and misconceptions.
I’ll try clearing them up with this primer:
Traditional and Roth IRAs are types of individual retirement accounts. Contributions to traditional IRAs may be tax deductible, but withdrawals are taxed. Roth IRA contributions are never deductible, but withdrawals can be tax-free. Converting a traditional IRA to a Roth offers the potential of future tax-free growth in exchange for being taxed on the conversion.
The conversion itself is merely a paperwork transaction. Your IRA custodian (basically, the institution where you have your account) can guide you through it. You may choose to convert all or part of the traditional IRA.
You don’t need "earned income," which is mostly income from work, to convert. You need earned income to make a direct contribution to any type of IRA, but conversions are not the same as direct contributions.
For 2009, you can convert unless your modified adjusted gross income is more than $100,000 or you are married and file separate tax returns. Beginning in 2010, anybody with a traditional IRA can convert.
To answer numerous questions, anybody means anybody, including you.
If your traditional IRA contains non-deductible contributions, they are not taxed on conversion. (If you convert a $100,000 IRA with $20,000 in non-deductible contributions, only $80,000 is taxable upon conversion.) But you cannot "cherry pick" and convert just the non-taxable amounts. Instead, you must pay your "pro-rata" share of taxes. If you convert only part of this IRA, for example, you would pay tax on 80 percent of the converted amount, the same ratio as in a full conversion.
Converted amounts can always be withdrawn from a Roth IRA without having to pay ordinary income tax (you already paid it when you converted) cash advance payday loan. But converted amounts withdrawn before five years are subject to a 10 percent penalty if you are under 59