While there may be income eligibility rules to contribute directly to a ROTH IRA, taxpayers who are above the income threshold may still be able to fund their ROTH IRAs through a ROTH Conversion.
A ROTH Conversion allows a taxpayer at any income level to convert Traditional IRA money to a ROTH IRA. The ROTH Conversion process in-volves paying taxes on pretax dollars now with the goal of tax-free growth going forward. A ROTH Conversion is considered a taxable event in the year the conversion occurred.
For example, if you owned a Traditional IRA that was funded with pretax dollars and you converted $50,000, you would report $50,000 in income in the year of the conversion. Going forward, though, you would receive the benefits of a ROTH IRA.
The ROTH Conversion strategy can be beneficial for taxpayers who feel they will be in a higher tax bracket in the future, want to diversify the taxation of their future income sources, or want to leave tax-free assets to their beneficiaries.
The ROTH Conversion strategy may not be beneficial for taxpayers who are in a high current tax bracket, may be in a lower tax bracket in the future, do not have the money now to pay the taxes, or do not have any dependents to leave tax-free money too.
It is important to weigh the short-term tax consequences with the long-term tax benefits of the ROTH Conversion to determine if the strategy is beneficial.