Do I pay tax when I rollover a Traditional IRA into a Roth IRA?

Yes. A distribution rolled over to a Roth IRA from a traditional IRA, qualified plan, tax-deferred annuity, or eligible deferred compensation plan is included in gross income (although not adjusted gross income for purposes of the $100,000 ceiling). A traditional IRA can be converted into a Roth IRA, but the conversion is treated as a distribution from the traditional IRA and a rollover contribution to the Roth IRA.

Starting in 2010, everyone qualifies to convert to a Roth IRA. As with any rollover, you will want to arrange a direct rollover from the plan to the Roth IRA to avoid mandatory income tax withholding and not worry about the 60-day window which the transfer must be completed.

A rollover or conversion from a traditional IRA to a Roth IRA is usually advantageous for taxpayers who can pay the resulting tax from other funds. Assume A, who is taxed at 30 percent at all relevant times, converts a traditional IRA containing $100,000 into a Roth IRA and pays the resulting $30,000 tax from other funds. Before the conversion, each dollar of income accumulated in the IRA faced a 30 percent tax on distribution, but the conversion eliminates this prospect. A accomplishes this by effectively investing an additional $30,000, after taxes, in the IRA, but this $30,000 will itself produce earnings within the IRA on which A will never be taxed. The conversion thus has the effect of a $30,000 nondeductible contribution to the Roth IRA, free of the usual annual ceiling on IRA contributions. The conversion is also advantageous if the taxpayer is taxed at a lesser rate for the year of the conversion than is expected in the year or years of ultimate distribution (e.g., because of losses or other large deductions in the year of the rollover or conversion).

If an amount “properly allocable” to a traditional-to-Roth rollover is distributed during the year of the rollover or any of the succeeding four years, the early distribution penalty tax of Internal Revenue Code Section 72(t) applies as if the entire distribution (or, if less, the gross income recognized at the time of the rollover) were included in gross income. The deemed gross income is taxed under Internal Revenue Code Section 72(t) unless the distribution is made after the owner of the IRA attains age 59 1/2 , becomes disabled, or dies or some other exception from the penalty applies.

Please contact one of our Roth IRA Experts at 800-472-0646 for more information.

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