Planning For Retirement: Using Traditional and Roth IRAs (GLBT)

There are many vehicles used fore retirement planning. One of the most common is the traditional IRA (individual retirement account). Since the federal government does not yet recognize same sex couples, the following discussion centers on lifetime rules of IRAs. At the death of the individual, continuation rules are different for survivors who are spouses, rather than non-recognized same sex couples. With those parameters set, let’s continue.

Contributions to IRAs are often tax deductible and distributions are often taxable as income. Another type of IRA is the Roth IRA in which contributions are made after tax and distributions can be tax-free. Tax-free withdrawals can be attractive which often prompts the question: Can a traditional IRA be converted to a Roth IRA?

The answer is yes, provided you meet the eligibility requirements below and understand how it works.

The IRA owner must not have gross income in excess of $100,000 in the year of the conversion. This income limit is repealed as of 2010.

The conversion will be treated as a distribution from the Traditional IRA. Therefore, any deductible contributions and gain will be taxable to the owner and included in income in the year of the conversion. If the IRA being converted includes additional benefits, the actuarial value of those benefits is also taxable at conversion.

The distribution is not subject to the 10% federal income tax penalty. And, for purposes of determining conversion eligibility, the conversion amount is not added to the individual’s adjusted gross income.

It is important to note that currently funds from an employer-sponsored retirement plan cannot be rolled directly into a Roth IRA. The money must first be rolled into a Traditional IRA and then may be converted to a Roth IRA. Beginning in 2008, employer-sponsored retirement plans will be able to be rolled directly to a Roth IRA. But the income limits on conversion will still apply.

Withdrawals of earned dollars made in the five-year period following conversion will be taxable. And, for the Roth owner under 59 ½, withdrawal of the conversion portion will subject the amount previously taxed at conversion to the 10% tax penalty. This prevents a Traditional IRA owner from avoiding the 10% penalty by first converting to a Roth IRA.

IRA transfers and rollovers are powerful financial tools. If properly handled, these transactions allow funds to be shifted between IRAs or withdrawn without paying income taxes. The end result is often greater convenience and/or greater control of funds for the IRA owner. If you think a transfer or rollover might make sense for you or your partner, contact a qualified financial professional.

Kurt Schummer is a Manager, Financial Services with The Prudential Insurance Company of America's Packerland Agency located in Wauwatosa, WI. He can be reached at kurt.schummer@prudential.com or 414-456-1770, ext. 7240. Prudential and its licensed financial professionals do not give tax or legal advice. Be sure to consult with your tax and legal advisors regarding your personal circumstances.