A Good Day to Convert to a Roth IRA

If you’re a real estate investor who took a loss this year, it might be a good time to consider a Traditional to Roth IRA conversion. 

Patricia McCrystal
June 25, 2015

The right time to make a conversion from a Traditional IRA to a Roth depends on several present and future factors that are unique to every individual investor's life. With a Roth IRA, cash is contributed "post-tax", meaning the contribution is made with taxable earnings for that year. This cash then buys assets (stocks, real estate, gold, etc.) on a tax advantaged basis. Assets can be bought, sold, or traded within the IRA without and without affecting the IRA holder's personal taxes.

With a Traditional IRA, cash is contributed "pre-tax", meaning the contribution is taken as a tax deduction from earned income for that tax year. This cash can then buys assets (stocks, real estate, gold, etc.) on a tax deferred basis. Like a Roth IRA, assets can be bought, sold, or traded within the IRA without incurring capital gains tax, and without affecting the IRA holder's personal taxes.

When you reach 59.5 years of age, you can begin to withdraw from a Traditional IRA without penalty. You then pay taxes on the amount withdrawn. Early distributions may be taken from a Traditional IRA without penalties for unusual circumstances like a first home purchase, or certain medical expenses.

A key incentive behind opening a Traditional IRA is the projection that you will be in a lower tax bracket when you retire, and that your initial contribution will have grown on a tax deferred basis. Most 401(k)s, 403(b)s, Thrift Savings plans, and 457s are within the same tax status as a Traditional IRA. 

One strategy behind converting from a Traditional IRA to a Roth lies in the projection that your tax bracket may be the same or higher upon distribution than at the time of contribution. Because Roth contributions are taxed when they enter the account, it could be beneficial to open a Roth IRA account when your anticipated yearly income is going to be less, and therefore your tax bracket is lower. 

If you made some less than successful real estate investments or suffered a rental loss this year, you may be able to turn your loss into a gain by paying lower taxes on your contributions, and eliminate speculation on your tax burden at the time of distribution. Roth IRAs are also popular with clients who anticipate a large return on their assets. If you think that fix and flip is going to rake in the big bucks down the road, you may choose to avoid paying taxes on the return by paying taxes on the initial contribution with a Roth IRA. 

Another benefit of the Roth IRA is the account holder’s ability to withdraw the principal amounts (your contributions) at any time without penalty or tax liability. When you reach 59.5 years of age, you can begin to take a distribution from the account (investment earnings included) without penalty and without taxes, as long as the account has been open for 5 years. Unlike a Traditional IRA, there are no Required Minimum Distributions (RMD) with a Roth IRA.

Both Traditional IRAs and Roth IRAs offer a unique array of advantages and conditions. The account that will best represent you and your retirement goals is wholly dependent on several present and future factors exclusive to your life as an investor. However, converting funds into a Roth IRA can be a silver lining to a particularly down year for real estate investors. Learn more about investing in real estate with your self-directed IRA at New Direction IRA's real estate page. And as always, happy investing!

Roth IRA Rules and Comparison

Since its creation in 1997, the Roth IRA has become a popular retirement solution for many investors. This popularity is largely due to the account’s unique advantages. While the Roth IRA isn’t the only way to plan for retirement, knowing its benefits can help you determine what kind of role the account can play in helping you prepare for your future.

Source: IRS.gov

 The first and foremost benefit of a Roth IRA is the account’s tax structure. A Roth IRA requires that contributions to the account occur with funds that have already had taxes taken out of them. This structure differs from a Traditional IRA gets funded with contributions be made with pre-tax funds. While you do have to pay taxes on funds that enter the account, any gains or earnings made by the funds in your Roth IRA are allowed to grow tax-free. Qualified distributions, funds withdrawn from the account after age 59.5 and after the account has been open for at least 5 years, are also tax-free.

Like a Traditional IRA, a Roth IRA can be funded through a contribution, transfer, or rollover. Unlike a Traditional IRA, the contributions made to a Roth IRA can be withdrawn at any time without penalties or taxes. These contributions are currently limited to $5,500 annually for individuals under age 50 and $6,500 annually for individuals over age 50. Income limits also apply to Roth IRAs. In order to be eligible to contribute to a Roth IRA, you must have earned income at least equal to the dollar amount contributed to the account. Individuals or married couples whose Modified Adjusted Gross Income exceeds certain IRS limits are also ineligible to contribute to a Roth IRA.

A Roth IRA can also be funded in a fourth way, through a conversion. This process involves taking a non-Roth retirement account- Traditional IRA, SEP IRA, SIMPLE IRA, 401(k)- and converting it to a Roth IRA by paying income taxes on previously tax-free account contributions. Currently, there are no limits on the amount of funds that can be converted to a Roth IRA. While converting non-Roth funds can help you take advantage of the benefits of a Roth IRA, this process does start a five-year requirement for qualified distributions on the converted funds. 

Beyond these benefits, the Roth IRA contains other advantages. Unlike non-Roth IRAs, you can continue to contribute to a Roth account after age 70.5. You are also not required to take a yearly minimum distribution from a Roth IRA after reaching age 70.5. Your Roth IRA can also help you purchase a home. The IRS allows a lifetime maximum of $10,000 that can be withdrawn tax and penalty free from the Roth account to purchase a principal residence for the account holder.

While the Roth IRA has many advantages, it is important to know how your current financial situation and retirement goals factor into the equation. Working with your financial team can help you determine how best to utilize a Roth IRA to realize your retirement dreams.