Roth IRA rollover

Roth IRA rollover

Host : OK, how about switching funds between a traditional IRA and a Roth IRA?

David : This is possible and is called a Roth IRA rollover. If your AGI is under $100,000, you can transfer your existing, traditional IRA funds into a Roth IRA.

The nice thing about this is your Roth IRA withdrawals are completely tax free after age 59.5. So by doing a Roth IRA rollover you avoid the taxes you'd normally have to pay on traditional IRA withdrawals.

Of course there is a catch...

Host : I knew there was a catch...

David : Hey, there's always a catch. When you make the rollover to a Roth IRA, you have to pay ordinary income taxes -- but no penalty -- on the amount rolled over. Otherwise, you'd escape paying taxes on the amount rolled over, and we couldn't have that, now could we?

Host : No, I guess we couldn't. So should someone do a Roth IRA rollover?

David : Again, that depends. If you do the rollover in 1998, you can spread the tax on the rolled over amount over 4 years. I think this is largely a gimmick to help politicians balance the budget by 2002.

Bear in mind, by allowing these rollovers, the government accelerates tax income in the short run, but gives up taxes in the future. Still, this feature makes considering rollovers particularly attractive in 1998, the only year this four-year averaging will be available.

But there are other times when it may be attractive to do a Roth IRA rollover.

Let's say you didn't work full time one year because you're between jobs or you had a new baby. You didn't work full time so your income is down and you may be in a low tax bracket. Now might be a good time to roll over your traditional IRA funds to a Roth IRA.

This strategy might save you money over the long run, but you might face a cash squeeze in the short run, so you need to be careful.

Remember you'll have to pay taxes on this rollover, and you'll need money to pay these taxes. But if you're between jobs, you might not have that money. So consider this option, but don't ever let tax strategy override common sense.