For many individuals who are saving for retirement, a Roth IRA can be very appealing. This is because you pay income taxes on the contributions when you add them to the IRA, versus paying your income taxes when you receive your distribution years from now. Individuals often feel to avoid future tax hikes, they would rather pay these now and thus enjoy a lower tax rate on their future income. Unfortunately, many individuals do not meet the IRS standards to start a Roth IRA because their current income exceeds the Roth IRA income limits. To determine if your income exceeds these limits, you should consult with your tax professional or accountant, such as Larry Gurewitz in Los Angeles, CA.
Conversion Taxes
When you begin the process of converting your traditional IRA to a Roth IRA, you will have to pay taxes on this rather large initial contribution. However, this is at your normal income tax rate. Therefore, the taxable amount is converted and then added to your income taxes to determine your tax liability for your total income in that filing year. Taxes must be paid in the same year that the conversion occurs. Therefore, you might find it favorable to do the conversion during a year when you are in a lower tax bracket and can absorb the increase of tax liability easier.
Meeting the Qualification to Convert to a Roth
However, once you have created a traditional IRA and contributed to it, then the IRS does allow for these to be converted into Roth IRAs. Yet until recently, high earners were still unable to take advantage. Now that has changed. Below are the criteria to be able to make the conversion.
Benefits of a Roth IRA
Roth IRAs offer many benefits in terms of retirement and tax planning for an individual. For a lower income year, a conversion can allow you to take advantage of a lower tax rate. Additionally, the income later received from the Roth will not be subjected to additional income taxes.
Another benefit is that the government could announce a higher tax rate in another year, so doing the conversion sooner allows for the taxpayer to take advantage of current rates to save money in the long term. Plus, funds contributed to a Roth will not be subject to any further income tax, thus you will not have to attempt to determine an after tax balance on the Roth IRA.
Other features that make this an attractive option for retirement savings:
Eligibility Rules for Roth IRAs
There are two eligibility requirements to determine if you can open a new Roth IRA or continue contributing to one. The first is your current year income and second is your tax filing status.
Your earned income for the year cannot exceed the amount that the federal government allows for those who hold Roth IRAs. The limits will depend on your tax status. If your earned income is less than the maximum set by the federal government, then you have a maximum contribution limit of $5,500. However, the higher your income goes, the more likely that you will be phased out of contributing.
Yet if you have been able to make a conversion, then it is important to contribute whenever the income limits allow you to do so. Additionally, if your income is less than the actual contribution limit of your Roth IRA, then you can only contribute up to the amount of your income for that year.
As you can see, a Roth conversion can be a practical tax planning option for retirement and give you additional contribution options.
Click on the link below to discuss with your tax professional or accountant from the office of Larry Gurewitz in Los Angeles, CA, to discuss the tax advantages of a conversion for your specific income and tax situation.
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