IRA to Roth IRA: The New Conversion Rules

Roth IRAs are awesome: I’ve been a huge fan ever since I first read about them and their unique benefits. You can contribute after tax money and allow it to compound tax free into the future. Not only that, you don’t have to start taking money out when you’re 70—you can let it compound even further. I’ve been contributing the full amount allowed ever since ($5,000 this year).

But the one catch Roth IRAs always had were that you couldn’t contribute if you made X amount of money. And that X is $176,000 for married filers and $120,000 for single filers. These people could still fund a traditional IRA and delay paying taxes, but the Roth was outside their grasp.

Which sucked.

But starting in January, a new provision is coming into effect that removes the ability for people making over $100,000 (AGI) to convert their IRAs to Roth IRAs. What does that mean?

These people pay the tax on the IRA now (at the current rate) and move the funds into a Roth IRA
This Roth IRA account is now free of taxes and functions like any other Roth IRA

Why is This Such a Big Deal?

Everyone thinks taxes are going to go up (we have been spending quite a bit, and there’s more on the way), so these people get to take whatever nest egg they have in their IRA and pay those taxes now at the current (low) rate. Without this change, they would’ve been forced to start withdrawing money at age 70 and paying taxes on it at the presumably higher rate.

Now they can leave that money in the Roth and not be forced to withdraw—they can even leave it to their grandchildren if they outlive the money.

One of the big factors in play here is whether or not the person has enough cash outside of the IRA account to pay for the taxes on the conversion. If you do have the cash, then this is an even better move because you get to put more money into this Roth account, where it will compound tax free. Since there are limits to how much you can deposit into a Roth every year, the bigger the pile you can start with, the better.

The other thing to consider is how long you have until retirement. The more time you have until you’re going to retire, the more time your Roth will have to compound tax free.

I’m not a tax or retirement pro, but this is a pretty big deal because people who didn’t have access to Roth IRA accounts are given the chance to put them into play.

While Roth IRAs are great and all, don’t forget that the best retirement plan is one that gives you flexibility. So having more than one type of retirement account is a good idea. For more on that, check out my post on 401(k) vs. Roth IRA accounts.