Thinking of converting to a Roth IRA?

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Key points

  • Partial conversions enable you to spread out your tax payments over multiple years
  • There are no income restrictions on Roth IRA conversions — anyone can make the switch
  • Roth IRAs generally provide federal (and possibly state) tax-free income in retirement and greater flexibility when it comes to distributions
  • Be sure to consult a tax advisor before making your decision
While there are tax considerations, converting your Traditional IRA or employer-sponsored retirement account to a Roth IRA may offer you more flexibility and control over your nest egg in retirement. Consider all of your choices and learn if converting to a Roth IRA might be right for you.

Anyone can convert

As long as taxes are paid on the conversion (i.e., pre-tax) amount, anyone can convert a Traditional IRA, or other eligible retirement plan asset1, to a Roth IRA. This presents an opportunity for investors who wish to potentially lessen their tax burden in retirement and enjoy greater flexibility as no distributions are required to be made to the original Roth IRA account holder. Of course, every financial situation is unique, so consult with a tax advisor to get help in determining whether converting to a Roth IRA is right for you.

But not everyone can contribute

While everyone is eligible to convert to a Roth IRA, due to modified adjusted gross income ("MAGI") restrictions, many taxpayers are prohibited from directly contributing to Roth IRAs. For example, if in 2016, your MAGI exceeds $132,000 as a head of household or single filer, or $194,000 as a married joint-return taxpayer,2 or if you are a married taxpayer who files separately3 and your MAGI exceeds $10,000, you are not eligible to contribute to a Roth IRA. In 2017, you are not eligible to contribute to a Roth IRA if your MAGI exceeds $133,000 as a head of household or single filer, or $196,000 as a married joint-return taxpayer, or if you are a married taxpayer who files separately and your MAGI exceeds $10,000.
In 2016 and 2017, eligible investors can contribute up to $5,500; $6,500 for those age 50 or older.4 However, the contribution limit declines for head of household or single filers with a MAGI of more than $117,000 in 2016 or $118,000 in 2017. In both 2016 and 2017, the contribution limit also declines for married couples filing separately with a MAGI of less than $10,000.

It's not an "all or nothing" proposition — consider a partial conversion

Pre-tax assets that are converted from a Traditional IRA or another eligible retirement plan to a Roth IRA are treated as a taxable distribution and are subject to ordinary income tax rates in the year of the conversion. You can do a partial conversion — that is, convert a portion of your assets over two years or more, thereby spreading out your tax payments. You don't actually have to convert the whole account at once.

Converting to a Roth IRA may be worth considering if you:

  • Have assets invested in Traditional IRAs or employer-sponsored retirement plans
  • Think you'll be in a higher tax bracket in retirement, or if you're temporarily in a lower tax bracket now
  • Can afford to take the tax hit now without dipping into your retirement account to pay the conversion taxes
  • Have unused tax deductions (such as charitable contributions or medical expenses) that can help offset the taxable income generated by the conversion
  • Wish to reduce the taxable value of your estate or potentially leave income tax-free assets to your heirs
Note that if you have multiple non-Roth IRAs, any conversion will be deemed to be made from all of the IRAs on a proportionate basis.

Understanding Roth IRAs

There are a variety of factors to consider before you determine whether to convert your Traditional IRA or other retirement account to a Roth IRA. Again, you should consult with a tax professional to assess the potential impact on your long-term financial goals before making any decisions.

How do they work?

Your assets will grow tax-deferred and can be distributed tax-free (on a federal and possibly state level) after five years5 if one of the following applies:
  1. You are age 59 ½ or older
  2. You qualify for a special purpose distribution for the purchase of a first home (lifetime limit of $10,000)
  3. You die or become permanently disabled
If you make a withdrawal that does not meet these or certain other qualifications, you will owe ordinary income tax on any taxable distribution (generally, any distribution of earnings) and, potentially, a 10% additional tax for taxable withdrawals prior to age 59 ½.6

What are the benefits?

Since income restrictions have been lifted on Roth IRA conversions, many investors are taking a hard look at the potential benefits —primarily, tax-free withdrawals and no mandatory distribution schedule —to determine whether a switch makes sense.
  • Avoid future taxation — While Roth contributions are not tax-deductible, qualified distributions are federal (and possibly state) income tax-free. This is a great perk if you anticipate being in a higher tax bracket when you withdraw your money — typically in retirement. Many investors hold a significant portion of their retirement savings in a tax-deferred plan — such as a 401(k) or other employer retirement plan — money that is taxed as income upon distribution. Converting some of your savings to a Roth IRA (accomplished through a partial or complete conversion) allows you to diversify your retirement assets from a tax perspective.
  • Enjoy greater flexibility — Roth IRAs offer you greater withdrawal flexibility. Unlike a Traditional IRA, Roth IRAs are not subject to required minimum distributions (RMDs) for the original account holder, so you are not required to begin taking distributions at age 70 ½ (although distributions will still be required after your death). You can also continue to contribute to your Roth IRA account for as long as you earn income, even after turning age 70 ½ (which is a feature that is not permitted for Traditional IRAs).
Next steps

1 The following account types are eligible for conversion to a Roth IRA: Traditional IRA, rollover IRA, SEP IRA and SIMPLE IRA (after held for 2 years), as well as assets in tax-qualified retirement plans such as 401(k), 403(b), 457(b), profit sharing and money purchase plans.

2 For this purpose, a qualifying widow(er) is treated a married joint-return taxpayer.

3 Married taxpayers who file separately but did not live together at any point during the tax year will be treated as single filers.

4 You are treated as being age 50 or older if you will turn age 50 or older at any point during the calendar year.

5 This five-year period begins on January 1 of the tax year for which the first contribution to a Roth IRA was made.

6 In addition, a special provision applies for converted assets. If a non-qualified withdrawal is made within five years following the beginning of the conversion tax year the entire withdrawal may be subject to the 10% additional tax for pre-59-1/2 withdrawals unless an exception applies.

You have choices for what to do with your employer sponsored retirement plan accounts. Depending on your financial circumstances, needs and goals, you may choose to rollover to an IRA or convert to a Roth IRA, rollover an employer sponsored plan from a prior employer to an employer sponsored plan at your new employer, take a distribution, or leave the account where it is. Each choice may offer different investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment, and provide different protection from creditors and legal judgments. These are complex choices and should be considered with care. Visit merrilledge.com/rollover or call a Merrill Edge® rollover specialist at 1.888.637.3343 for additional information about your choices.

Did you know that there are two ways to move assets from one IRA to another? The most common is a transfer. This is when you transfer assets from an IRA held at one financial institution to an IRA at another. You may directly transfer assets between investment firms as frequently as you wish. The second, less common approach is called a rollover. Rollovers occur when you withdraw assets from an IRA and then "roll" those assets back into the same IRA or into another one within 60 days. Tax code rules limit you to one rollover per IRA owner per twelve month period. If you have questions or want to learn more call 1.888.637.3343 or consult a tax advisor.

Investment involves risk. Diversification does not ensure a profit or guarantee against loss.

Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

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