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If you’re eligible to convert your traditional IRA to a Roth IRA, here are some reasons to consider making the move.
If you convert your traditional IRA to a Roth IRA, once you retire you won’t have to pay any taxes on the qualified withdrawals you make from a Roth IRA. In contrast, you have to pay income taxes on the taxable portion of your traditional IRA withdrawals.
The upshot: Depending on your specific situation, you may end up with more money in your Roth IRA than your traditional IRA.
Before you can convert, however, you have to pay the taxes on the amount that’s been accumulating tax deferred in your traditional IRA. That’s why it’s important to evaluate whether the tax-free benefit of a Roth IRA outweighs the taxes you have to prepay upon conversion.
Once you convert to a Roth IRA, it’s best to leave your savings accumulate as long as possible for your retirement. Especially since you’ll have to pay conversion taxes up-front to gain the benefit of future tax-free earnings. If you really need the money, for an emergency, for example -- a Roth IRA has some withdrawal pluses over a traditional IRA.
Specifically, the first dollars you withdraw from a Roth IRA are considered to be a return of any regular annual contributions you made. Accordingly, you can withdraw these regular contributions at any time, for any reason, with no federal taxes or penalties due.
Then once you’ve withdrawn the entire amount of any regular annual contributions, the next dollars out are considered to come from any amounts you converted from a traditional IRA. After you’ve satisfied the five-year holding period requirement, you can withdraw these conversion amounts free of penalties – even if you’re under age 59½.
You won’t owe income taxes on the conversion amounts either, because you already paid the tax due when you made the conversion.
Once you’ve withdrawn your regular annual contributions and any conversion amounts, however, you’re dipping into your earnings. And if you withdraw any of these earnings early, you will incur taxes and possibly penalties.
In contrast to a traditional IRA, you’re not required to begin taking minimum distributions from a Roth IRA at age 70½. Therefore, you can let your IRA earnings accumulate tax free longer and take your money out on your own timetable. (Minimum distributions rules do apply, however, after the death of the IRA owner.)
And if you don’t need your Roth IRA to live on in retirement, you can leave it to your heirs who will receive qualified distributions free from federal tax. Furthermore, if you have significant assets, you may be able to use your Roth IRA as a funding vehicle for some types of trusts.
Article is for educational purposes only and is not intended to provide specific tax or legal advice. For answers to tax questions, please see your tax professional. For legal questions, consult an attorney.
Representatives are registered, securities are sold, and investment advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA/SIPC, a registered broker/dealer and investment advisor, 2000 Heritage Way, Waverly, Iowa 50677, toll-free (800) 369-2862. Nondeposit investment and insurance products are not federally insured, involve investment risk, may lose value and are not obligations of or guaranteed by the financial institution. CBSI is under contract with the financial institution, through the financial services program, to make securities available to members. CUNA Brokerage Services, Inc., is a registered broker/dealer in all fifty states of the United States of America. The Representative may also be a credit union employee that accepts deposits on behalf of the financial institution.
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