Roth IRA Conversions – Eligibility, Types of Conversions and Adjusted Gross Income Limits

The Roth IRA is a better choice than traditional IRA because contributions are made after-tax adding greater tax leverage to your retirement savings allowing you to grow your savings tax-free and withdraw them tax-free! What happens if you already have a traditional IRA and would like to convert it to a Roth IRA? This is where Roth IRA conversions come into play!

Qualified Roth IRA Conversion

In order to successfully convert a traditional IRA to a Roth IRA, the conversion must be ‘qualified.’ Roth IRA conversions are treated as rollovers at all times, regardless of the method used. There are 3 of these methods, discussed below:

i) Rollover – You can take a distribution from a traditional IRA and roll it over to a Roth IRA within 60 days. To meet the 60 day rule, count the day you receive the check and include the day when you deposit the money into your Roth IRA. For example if you get the check on April 1st, 2010, you must have it deposited by May 30th, 2010. There is no extension granted for holidays and weekends.

ii) Trustee-to-trustee transfer – You can instruct the trustee of your traditional IRA to make a direct payment to the trustee of your Roth IRA. This is also considered a qualified rollover.

iii) Same-trustee transfer – If you have only 1 trustee for both your traditional IRA and your Roth IRA, you should instruct the trustee to transfer directly from traditional to Roth IRA.

Adjusted Gross Income Limits

The law states that if your adjusted gross income (AGI) is greater than $100,000, you cannot convert from a traditional IRA to a Roth IRA. This law applies to both singles, married filing joint & head of household filers. Note that if you are filing a married-filing-separate tax return, you are not eligible to convert a traditional IRA to a Roth IRA at all, no matter what your adjusted gross income is.

An interesting question asked is, what if you made a Roth conversion last January and find out that your adjusted gross income will exceed $100,000? If this happens, there is nothing to worry about. You can convert your Roth IRA back to a traditional IRA via a few simple procedures known as IRA Recharacterizations.


John has an AGI of $85,000. He also has a traditional IRA of $55,000 that he would like to convert to a Roth IRA. John’s official adjusted gross limit (AGI) threshold for the year would be $85,000. Note we do not include the $55,000 conversion in the AGI limit because the law forbids that.

Taking Qualified Roth IRA Distributions – Eligibility & Examples

Any ‘qualified distributions’ you take from a Roth IRA will NOT be included in your taxable income, hence making you exempt from paying taxes. You won’t have to pay taxes on the original principal you contributed nor any taxes on capital gains & earnings you have accumulated. Pretty sweet you think for Roth IRAs, eh? In order for the distribution to be classified as ‘qualified’, it must be taken under 1 of the following circumstances:

the Roth IRA investor must be 59 and 1/2 years or older at the time of the distribution
the Roth IRA investor becomes disabled at the time of taking the distributions
the Roth IRA investor dies and his/her beneficiary receives the assets contained in the plan
the distributions taken from the Roth IRA will be used in the purchase or building of a new home for the Roth IRA holder or qualified family member.This is limited to $10,000 per person per lifetime. Qualified family members include:
–> the Roth IRA investor
–> the Roth IRA investor’s spouse
–> children of the Roth IRA investor
–> grandchildren of the Roth IRA investor
–> parent or ancestor of the Roth IRA investor

Note: Even if one of the above prerequisites is met, the Roth IRA must be atleast 5 years old before any distributions can be taken. This is a very important point to consider. For example if you set up your Roth IRA in March 22nd, 2003, you cannot take any distributions, even if they are qualified, until March 22nd, 2010. If you do, this distribution will not be qualified and you will have to pay the 10% early withdrawal penalty as well as income taxes. A few examples to illustrate these concepts would be useful. Here they are.

Example #1

Jim makes Roth IRA contribution on March 1st, 2002 for $3000. 6 years later on March 1st, 2010, Jim withdraws $5500 from his account (the principal $3000 + $2500 earnings). Jim’s withdrawal is not qualified because he does not plan to purchase a home for the first time, nor is he disabled, plus Jim is not 59 and 1/2 years old or more. Jim will face a 10% early withdrawal penalty + have to pay income taxes on his withdrawal. If Jim had withdrawn only $3000 from his Roth IRA which equals the total contributions he made, he would not be subject to income taxes nor the 10% early withdrawal penalty. This is because Roth IRAs allow you to withdraw up to the maximum contributions you have made and not any earnings on those contributions. Since withdrew the whole $5500 consisting of $3000 principal + $2500 earnings, he will be penalized.

Example #2

Rishi who is 58 years old makes a $3500 contribution to his Roth IRA on April 12th, 1999 for the tax year 1998. On February 5th, 2003, Rishi withdraws $6000 from his Roth IRA consisting of $3500 original principal + $2500 earnings. At this time, Rishi is 62 years old. Will this distribution be treated as ‘qualified’? You bet it is! This is because the 5 year waiting rule has passed. Even though Rishi made his contribution on April 12th, 1999, this contribution was designated for the tax year 1998. Thus from 1998 – February 5th, 2003, the 5 year waiting rule is met. As you can see from here, it is not necessarily the calender years that count; it is when the first contribution was made and for what year it was designated. Also, Rishi is 62 years old which meets the 59 and 1/2 year old requirement. Thus this distribution of $6000 will not be included in Rishi’s taxable income.