One of the biggest benefits of IRA conversion is being able to take advantage of a different tax status. The big advantage of this strategy is that investors will not have to pay taxes on investment gains in the future. One of the drawbacks of this strategy is that the investor will have to pay income taxes on the money that is included in the IRA conversion. Another disadvantage is that when an individual converts to a Roth IRA, his or her contributions will be limited by annual income.
The process of IRA conversion involves moving retirement dollars from a traditional IRA to a Roth IRA. The purpose of doing this is to change the tax status of the retirement dollars. With a traditional IRA, the money is contributed to the account on a pretax basis. The money in the account is allowed to grow tax-free and then the individual will have to pay taxes on the money as it is withdrawn during retirement.
By going through an IRA conversion to a Roth IRA, an investor can fund the account with after-tax money. At that point, any money that is gained in the account will not have to have taxes paid on it. Even when the individual retires and starts to withdraw money, no taxes will be due.
One of the big disadvantages of implementing an IRA conversion is that the individual will have to pay taxes on the amount of money that is converted. When money is put into a traditional IRA, no taxes are paid on the amount that is deposited. Since Roth IRAs are funded with after-tax money, an individual who is converting will have to pay taxes on the amount of money being converted over to this type of account. This can amount to a substantial amount of taxes. This could cut into the amount of money in the retirement account or it could force the individual to pay for the taxes out of other money.
When an investor puts money into a traditional IRA, there are no income limits for him or her to worry about. When that investor switches over to a Roth IRA, this is no longer the case. Roth IRA investors are subject to income limits to determine if they are eligible to participate. If the investor's income goes above a certain amount every year, they will not be able to contribute.