As we enter the tax season, more often than not a handful of clients and do-it-yourself investors will ask the question, “So what’s the difference between a Roth Contribution and a Roth Conversion?” The question usually follows a conversation where the two terms were used interchangeably to describe the process of adding additional sums of money to one’s Roth IRA. So let’s take a look at the two processes which are as similar as apples and oranges.
Most investors are familiar with the Roth Contribution. This is the process when the owner of the Roth IRA deposits or contributes an amount to their Roth account up to their earned income or $5,500 ($6,500 if you are over 50) whichever is less. The opportunity to make a Roth contribution begins to phase out for 2014 when your income reaches $181,000 to $191,000 for those married filing jointly and for single, head of household or married filing single, the phase out for contributions is between $114,000 and $129,000. If you are eligible you have until April 15, 2015 to make your 2014 Roth IRA Contribution.
The Roth Conversion is very different but accomplishes the same goal of depositing money to one’s Roth IRA. However the money is transferred or converted from an investor’s Traditional IRA to their Roth IRA. Assets in the Traditional IRA generally grow tax-deferred until withdrawn and assets in a Roth IRA generally grow tax-free. When a Roth Conversion takes place, the converted assets from the Traditional IRA will be taxed as ordinary income in the year of conversion. Once in the Roth they too will grow tax free. It’s too late to make a Roth Conversion for tax year 2014 since the deadline was December 31, 2014. However you can start planning now to determine if a Roth Conversion in 2015 is a prudent option. There are no age or income limits on Roth Conversions. Keep in mind if you do decide to make a Roth Conversion, because it is taxed as ordinary income, the conversion could push you into a higher tax bracket. It’s always a good idea to seek advice and direction from a tax professional when considering a Roth Contribution or Roth Conversion.
So there you have it! While we could spend hours discussing the intricacies of Roth Contributions and Roth Conversions, hopefully now you understand the very basic differences between the two. Just like apples and oranges.