In 2016, to make a full contribution to a Roth IRA, your modified adjusted gross income must be less than $183,000 if you are married filing jointly ($116,000 if you are filing single).
But, no matter what your income level and tax filing status is, you are eligible to make a Roth conversion. What is the difference?
Income limit eligibility: $184,000 (1)
Max/year: $5,500 ($6,500 over 50 years old) (2)
Source: Taxable account
Tax consequences: No tax benefit in the year of contribution
Income limit eligibility: No limit
Max/year: No limit
Source: Tax deferred retirement account
Tax consequences: Amount converted is taxed as ordinary income in year of conversion
The biggest difference between a contribution and a conversion is the source. A Roth conversion is moving money you have already saved in a tax-deferred retirement account (like a 401(k) or a deductible traditional IRA) into a Roth IRA. That triggers a taxable event because that money has never been taxed. Any amount that is converted will need to be claimed as ordinary income for that year.
A Roth contribution’s source is not another retirement account. It needs to be from a taxable account, like a checking/savings account or a non-retirement brokerage account. It is “new” retirement savings.
Roth money grows tax free. Rightfully so, the tax-free growth is the obvious attraction to saving for retirement in a Roth IRA. But, unlike a deductible traditional IRA contribution or a pretax 401(k) contribution, there is no current tax benefit to Roth contribution or conversion.
The question of whether to make a Roth contribution (if eligible) or Roth conversion in any given year is a tax question – both current and future. The concept would be: is paying tax on retirement savings now, in your given tax bracket, more beneficial long term to not pay tax later in your (or your heirs’) future tax bracket? Keep in mind that an amount converted to Roth could be paying tax at a higher tax bracket than your other income if it puts you over the threshold of another tax bracket.
As with most tax efficient strategies, it is a year-by-year assessment. Working with an advisor should help you answer these questions.
(1) For married filing jointly filing status in 2016
(2) 2016 amounts
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