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Roth IRA Conversion Rules

Roth IRA accounts have income limitations that prohibit high-income taxpayers from contributing to a Roth IRA. However, starting in 2010, all taxpayers may convert other qualified retirement assets into Roth IRAs. Previously, only people with an adjusted gross income below $100,000 were premitted to do Roth conversions.

The provision that allowed Roth conversions in 2010 for all taxpayers regardless of income was made permanent. However, special rules regarding the taxation of conversion amounts is only good during 2010.

Roth IRA Conversion Taxes

To convert a traditional IRA to a Roth IRA taxes must be paid on all previously non-taxed dollars. Any deductible IRA contributions as well as all gains and income earned within an IRA account are taxed.

Any non-deductible contributions made to a traditional IRA account are not taxed again.

For example, a person who contributed $2,000 each year to an IRA account for seven years, and deducted those contributions from their taxes would have to pay ordinary income taxes on all $14,000 in IRA contributions.

Furthermore, if that person had investment gains resulting in a total account balance of $20,000, then the $6,000 in gains would also be taxed at ordinary income tax rates.

There are no penalties for converting an IRA.

A Roth IRA conversion is not considered an early withdrawal, and as such converting to a Roth IRA can be done at any age without penalty.

There is also no upper age limit or other age restriction on Roth IRA conversions. A taxpayer may convert some or all of their qualified retirement accounts to a Roth IRA account even if they are over age 70 1/2 and have begun taking Required Minimum Withdrawals, or RMDs.

However, monies converted to a Roth IRA may not be used to satisfy a required minimum distribution.

For example, if a taxpayer has an RMD of $4,000, that $4,000 must be withdrawn from the traditional IRA, or other retirement account, regardless of how much is converted. Remember RMDs are calculated based upon the account value as of December 31 during the previous tax year. That means that no matter what happens during the current tax year, that distribution must be made.

You cannot use a Roth IRA conversion to avoid taking an RMD for the tax year. However, converting to a Roth IRA can eliminate the need to take future RMDs.