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Planning for Retirement: Using Traditional and Roth IRAs

Many vehicles are available for retirement planning. One of the most commonly used is the traditional IRA (individual retirement account). The following discussion centers on lifetime rules of IRAs. Upon the death of the IRA holder, continuation rules differ for a survivor who is a spouse (including a same-sex spouse for a couple married in a state that recognizes same-sex marriage) and one who is a partner in a same-sex couple but not recognized as a spouse under applicable state law.

Contributions to traditional IRAs are often tax-deductible; distributions are often taxable as income. Another type of IRA is the Roth IRA, in which contributions are made after tax and distributions can be tax-free. In some cases, it makes sense to convert a traditional IRA into a Roth IRA to take advantage of tax-free withdrawals. When considering doing so, you must take the following into account:

  • Conversion is treated as a distribution from the traditional IRA. Therefore, any deductible contributions and gain is taxable and must be included in the owner’s income in the year of the conversion. If the IRA being converted includes additional benefits, the actuarial value of those benefits is also taxable at conversion.
  • Distribution is not subject to the 10 percent federal income tax penalty.  However, if a portion of the IRA is withheld for income tax at the time of conversion, that part is subject to the tax penalty.  So, it is better to have other sources to use to pay the tax on conversion. Employer-sponsored retirement plans can be rolled directly to a Roth IRA.
  • Withdrawals of earnings made in the five-tax-year period following the opening of the first Roth IRA  will be taxable. To be income tax-free, the withdrawal must also be made after reaching age 59 ½, death or disability of the owner, or a first-time home purchase ($10,000 lifetime limit). And if a Roth owner under 59½ withdraws the conversion portion within five years of conversion, the amount previously taxed at conversion will be subject to the 10% tax penalty. This prevents a traditional IRA owner from avoiding the 10% penalty by first converting to a Roth IRA.

IRA Transfers and Rollovers

IRA transfers and rollovers are powerful financial tools. If these transactions are handled properly, funds can be shifted between IRAs or withdrawn without paying income taxes. The end result is often greater convenience and/or greater control of funds for the IRA owner. If you think a transfer or rollover might make sense for you or your partner, contact a qualified financial professional.

Prudential Financial, its affiliates, and their financial professionals do not render tax or legal advice. Please consult with your tax and legal advisors regarding your personal circumstances.
The Prudential Insurance Company of America, Newark, NJ.