Understanding Rollover IRA/Roth IRA Conversions

30 Apr

One of the most confusing parts of an IRA rollover is the difference between the many types of retirement accounts and the taxation involved. This can lead to some complications, especially when you’re dealing with rollover IRA to Roth IRA conversions. One of the first things you’ll need to understand about Roth IRA rollover is that the funds that are invested in the account have already been taxed, whereas in a traditional IRA rollover, the money has been invested without any taxes removed. For this reason, if you’re doing a Roth IRA transfer from a traditional account, you’ll have to ensure that the necessary taxes are withheld.

Because of the tax dynamics involved, you can’t really do a Roth IRA/Traditional IRA rollover.  This is because when money is removed from a Roth IRA account it is not taxed since taxes were already taken out before the money was put into the account.  However, in a Traditional IRA account the money is taxed when it is removed because taxes were not withheld before money was put into the IRA.  This means that if you do a Roth IRA transfer to a Traditional IRA, then you will have to pay taxes on it again when it is withdrawn, and this is an unnecessary waste of money.

Something else to consider if you are doing a Roth IRA rollover is whether you are going to go through with an indirect or direct transfer.  In most scenarios you would want to go with the direct transfer, and this is probably also the case with the Roth IRA conversion.  When you do a direct transfer the money is moved between banking institutions and you do not have to worry about the handling of the money or the taxes because they are taken care of by the banks.  This will help to ensure that when you are converting to a Roth IRA from a Traditional IRA that the appropriate amount of taxes are withheld so that you do not end up with problems later.

In an indirect transfer the money from your existing IRA account is issued to you in the form of a check.  However, twenty percent of the total is withheld for taxes.  You then have sixty days to move the money into a qualifying account.  During this time you will want to open a Roth IRA account and make sure that you deposit the total check.  Then, the twenty percent is released for taxes, and if necessary additional taxes will be taken out of the Roth IRA to pay for the conversion.  This is a complicated and troubling process, and it can end up causing you a lot more stress than it would to just let the banks deal with it.  The upside is that it does allow you more of a hands-on approach.

If you are looking to make sure that your Roth IRA conversion goes well, you just have to follow a few simple rules and you can easily make a transfer from a Traditional IRA to a Roth IRA.

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