The tax code offers two types of IRAs; one is referred to as the traditional individual retirement account (IRA), so named because it was the first type of IRA available, having been created by Congress back in the 1970s. The second type is the Roth IRA, established in 1997 and named after William Roth, who was a senator from Delaware. Which one is best for you?
Roth IRA accounts provide the benefits of tax-free accumulation and, once you reach retirement age, tax-free distributions. This is the reason why so many taxpayers are converting their traditional IRA account to a Roth IRA. However, to do so, you must generally pay tax on the on the converted amount. After making a conversion, your circumstances may change, and you may find yourself wishing you had not made the conversion. In the past, you could change your mind later and undo the conversion. But that option is no longer available under tax reform. So, be careful: once a conversion is made, there is no going back.
Timing is everything, and a favorable time to make a traditional IRA to Roth IRA conversion is a year when your income is abnormally low or the value of your traditional IRA has declined. You can also convert portions of your traditional IRA over a number of years, thereby gradually converting the traditional IRA to a Roth IRA, spreading the tax liability over a number of years, and keeping it in a lower tax bracket. If you previously made non-deductible contributions to a traditional IRA, those amounts can be converted tax-free but must be converted ratably with the other funds in the traditional IRA.
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When you convert a traditional IRA to a Roth IRA, you have to pay the tax on the conversion. However, individuals frequently do that this so they can take advantage of future tax-free accumulations. Distributions from Roth IRAs are generally tax free, including any earnings (accumulations) while the account is a Roth account.
Are you considering converting your traditional IRA to a Roth IRA in 2017? Are you hesitant to do so because of uncertainty about the timing and specifics of the Administration’s and Congress’ proposal to cut tax rates for individuals? Have no fear, because you can convert your traditional IRA to a Roth IRA this year, and if tax reform passes with lower tax rates effective next year, you can undo the conversion for 2017 and then re-convert for 2018.
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Taxpayers can take a distribution from an IRA or other qualified retirement plan and if they roll it over (put it back) within 60 days they can avoid taxation on the distributed amount. (This provision does not apply to required minimum distributions for taxpayers who are 70.5 years of age and over.) In addition, taxpayers are limited to one IRA-to-IRA rollover per year.