Basic Questions

[Guest l_bhargava]

Hi All,

I have a 401K plan from my previous employer, which I want to rollover. I have been thinking of first a Traditional IRA and then convert it to Roth. The reason I wish to do this is so that I may have cash available when I need it (I know it is not a good option to tap retirement funds like this). I have been doing a lot of reading and honestly I am totally confused.

My question is will I be penalised (10%) if I withdraw from my converted Roth IRA say after 2 months of deposit.

I have been more inclined towards Roth as I figure when I retire I may end up in a higher tax bracket. Is this a good option (Roth IRA that is).

Thanks in Advance

[papogi]

Yes, you will have to pay a penalty if you withdraw funds from a Roth IRA after only 2 months. You must keep it there for 5 years. After that, a withdrawal of Roth IRA funds before you are 59 1/2 results in the earnings being taxable, and a 10% penalty applies if the money is not used for a qualified expense. Qualified expenses include a down payment if you are a first-time home buyer, or expenses related to higher education. There are other QE's, but these are the more commonly used ones.

While it is usually a good idea to convert regular IRA's to Roth IRA's (not in every case, but most), understand that the conversion will result in your paying taxes on probably the entire amount. Your 401K was most likely made up of pre-tax deductions from your pay, as well as non-taxed employer contributions. A Roth IRA is, by design, comprised of taxed funds (hence the tax-free nature upon their withdrawal at retirement), so when you convert your regular IRA into a Roth, you will need to report that entire amount as taxable income in the year you make the conversion.

Without knowing your specifics, Roth IRA's are generally better than regular IRA's because the tax-free withdrawals will be much easier to manage (less paperwork), many people end up in a higher tax bracket when they retire (as you predict), and the lack of mandatory withdrawals form Roth IRA's (simplifies some areas of estate planning). Each person needs to run the numbers to see whether a deductible IRA or a non-deductible Roth IRA works better for them. Most find the Roth option better.

[Guest l_bhargava]

Thanks papogi your response helps a lot.

[John G]

I continue to be amazed at the number of people who are new to Roth IRAs that jump from "just getting started" to "how can I get my money out". OK, you and others may just want to understand the rules.... But, it seems to me that a lot of folks just don't get the basic point.

A Roth is a tax shelter, and you get value from this tax shelter by keeping your money inside the shelter. Borrowing for a home or education may sound great but it kills off the benefit of starting early with a Roth. If a tax payer can't keep their hands off a Roth, perhaps they have insufficient cash reserves or are not planning their financial path very well.

Just some generalizations... but if you contribute to a Roth or do a conversion and want the big benefits.... leave the money grow a long long long time.

[Guest l_bhargava]

Thanks John, I am aware of what you said and my mistake that I thought of "withdrawl" as on option and do agree that the money should be left in for a "long long time"