Avoid Tax Penalties: 3 Common Mistakes in Traditional to Roth IRA Conversions

Converting a Traditional to a Roth IRA in a fairly straightforward process. However, you must be aware of common mistakes to avoid penalties.

#1 Failing to Make the Tax Calculation

A Roth IRA uses post-tax dollars, and the income in the account grows tax free. A Traditional IRA does the opposite: no taxes are paid up front, and taxes are paid on the back-end. This difference means you will owe a tax payment when you initially convert the funds that you have not paid taxes on in your Traditional account. You must pay taxes on them in order for them to go into your Roth IRA.

#2 Delaying the Conversion

You have 60 days to deposit all funds into your new IRA account. If you are changing plan providers or accounts, make sure this happens on schedule, or you will be assessed a 10 percent early withdrawal fee.

#3 Ineligible Rollovers

You cannot convert or otherwise rollover money that was supposed to be removed through a Required Minimum Distribution (RMD). You will need to remove these funds first. Otherwise, you will face a 50 percent penalty on any money that was supposed to be withdrawn as a result of RMD rules.