Know all the rules before jumping on retirement plan bandwagons

“Converting from a traditional to a Roth IRA is a hot topic this year,” according to Karen Chan, CFP® and consumer and family economics educator with University of Illinois Extension. “As of 2010, anyone is eligible to convert. This is the only year in which a taxpayer can convert but spread the taxable income across two years, 2011 and 2012. However, barring new legislation, tax rates will increase in 2011. Add all those things together, and conversions are getting a lot of attention.”

Before jumping on the band wagon, Chan suggests that you take a step back and make sure that you know all the rules.

First, understand the appeal of Roth IRAs. All earnings in the account will be tax free if two criteria are met: when distributions are taken, the account has been open at least five years and the owner is age 59 ½ or older, is disabled, uses the money for first-time homebuyer expenses, or is deceased. Also, you will never be required to take any distributions from the account during your lifetime. If you don’t need the money, you can pass all those wonderful tax-free earnings to your heirs, but heirs will be required to take distributions.

You can do a conversion at any age without penalty. The downside is that you will pay federal income tax at your marginal tax rate on the conversion. “If you’re under age 59 ½, beware of two catches,” Chan advises. “If you use money from your IRA to pay the tax, you will pay a 10 percent penalty on that amount, and if you take converted money out of the Roth IRA before age 59 ½, you’ll also owe a penalty.”

If you have a required minimum distribution for the year of the conversion, you must still take the distribution—that amount cannot be converted.

Another potential “gotcha” awaits people who convert funds from a SIMPLE IRA. “Until you have participated in the SIMPLE plan for two years, you cannot move that money into anything except another SIMPLE plan. If you move the money into anything else, including a Roth, you will pay a 25 percent penalty,” says Chan.

Non-deductible contributions can be converted tax-free. However, Chan points out, you cannot convert just the non-deductible contributions. You must add together the balances in all of your tax-deferred IRA accounts (traditional, SEP, and SIMPLE IRAs) and calculate the proportion of that total that is from nondeductible contributions.

“You may need to make estimated tax payments or increase your withholding for the years in which you will recognize the income from the conversion,” Chan warns. Otherwise, you might owe penalties for underpaying your taxes.

Conversions can be un-done, or recharacterized, as late as the due date (including extensions) for the tax return for the year in which you did the conversion. So you could have until Oct. 15, 2011 to change your mind about a conversion done in 2010 and put the money back into a Traditional IRA.

For more information about Roth conversions, check the February posts on the Plan Well, Retire Well blog at You can also visit to read about Taking Distributions from Tax-Deferred Retirement Plans.

If you have other questions concerning consumer issues, call the Peoria County Extension Office. The number is 309-685-3140 or

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