Traditional Ira To Roth Rules

An Individual Retirement Account (IRA) is a retirement account that has tax advantages over other types of savings accounts. A Roth IRA is a specific type of IRA established by the Taxpayer Relief Act of 1997. A Roth IRA has some significant differences from a traditional IRA that you should consider if you wish to transfer your retirement savings into a Roth IRA.

Tax Deferment

The contributions to a traditional IRA are tax-deferred, meaning you don't pay taxes until you withdraw the money from the traditional IRA. You are required to pay the taxes on the contributions to a Roth IRA when you make the deposit to the Roth IRA.

Earnings

The fact you've already paid taxes on the Roth IRA means a Roth IRA has much fewer restrictions on when you can withdraw money from it. Money earned by the Roth IRA such as interest, capital gains and dividends aren't taxed until it's withdrawn from the account.

Early Withdrawal Penalties

Withdrawals that are made from a traditional IRA are taxed as income and also incur a penalty if the account holder isn't at least 59½ years old. The direct contributions to a Roth IRA can be withdrawn without penalty. The earnings can also be withdrawn without penalty once a specified period of time called the seasoning period has been reached. The seasoning period for a Roth IRA is five years as of 2009.

Home Purchase

The account holder can also withdraw a specific amount of tax-free earnings from a Roth IRA for the purpose of buying a home. The account holder must be a first-time home buyer and it must be the account holder's principal residence.

Adjusted Gross Income

The contributions to traditional IRAs reduce the account holder's adjusted gross income (AGI.) In contrast, contributions to a Roth IRA don't reduce the account holder's AGI. A larger AGI means the taxable income will be larger. This may disqualify the account holder of the Roth IRA from tax credits or tax deductions. Common examples of these include the earned income credit, the child tax credit and the student loan interest deduction.