Time is quickly running out! In another two months (December 31, 2010) it will be too late to take advantage of the IRS rules that allow a one-time opportunity to convert your Traditional IRA to a Roth IRA under favorable tax terms. Let’s explain. Starting in 2010, and thereafter, the $100,000 earned income limit previously imposed on Roth Conversions is eliminated. The amount converted is included as ordinary income for the year in which it was converted.
However, here is the KEY! If converted in 2010 only, taxpayers can elect to defer half of their tax liability to be paid in the tax year 2011 and the other half in 2012. This means that taxes are due April 15, 2012 and 2013, respectively, an attractive deal. After conversions, the Roth account will grow and be distributed TAX FREE as long as distributions are not taken within five years of the first contribution or conversion, and not before age 59-and-a-half. Here’s how a Roth IRA is different from a Traditional IRA:
1. With a Traditional IRA, you make contributions with pretax dollars, but pay income taxes when you receive distributions at retirement. The Roth IRA is just the opposite: you make contributions with after-tax dollars, but receive tax-free distributions at retirement.
2. Roth IRAs are only available to individuals who earn less than $120,000 or couples who earn less than $177,000.
3. The Roth IRA does not impose Required Minimum Distributions starting at age 70and-a-half. So why would you want a Roth IRA?
The current stock market decline provides a low-cost conversion opportunity: Since many stocks and mutual funds are depressed, converting and paying the tax man now while allowing future growth (hopefully) to occur tax free could be a better strategy. But, you ask, what if my investments continue to lose value after conversion, and I paid a tax on a higher amount? There is a ONE-time chance to convert the account back to a Traditional IRA — tax-free.
Roth IRAs can be a hedge against increases in income tax rates: Many believe (including me) that income tax rates will be higher in the future. If true, Roth IRAs are ideal because you can pay taxes at a lower rate now than in retirement.
Roth IRAs give you the opportunity to “gross up” the value of your retirement account: Since it is not necessary to pay the taxes due from the IRA account itself, it is wise to pay taxes with out- of-pocket funds instead of with assets from the IRA. This has the effect of “grossing up” the value of the Roth IRA because tax-free dollars have more purchasing power than pre-tax dollars.
Roth IRAs are not subject to Required Minimum Distribution (RMD) Rules: This is big for those who can afford to live on other non-retirement assets. It affords the luxury to pass all of the assets of a Roth IRA onto their heirs.
Roth IRAs are an important estate planning tool: Individuals with large estates can use the Roth IRA to eliminate certain retirement assets from both Income and Federal Estate Taxes at death. Beneficiaries can stretch the account tax-exempt over their lifetime: Both Traditional and Roth IRAs permit a named beneficiary to stretch the annual minimum required distribution over his or her life expectancy. However, the Roth IRA permits the undistributed amount to continue to grow tax-free as opposed to the Traditional IRA , which is merely tax-deferred. A beneficiary with many years of accumulation may receive a very significant tax savings.
These points are all compelling when deciding to convert to Roth IRAs. However, IRA account owners should consider the tax ramifications, and age in regards to executing a Conversion from a Tradition IRA to a Roth IRA, or a Re-Characterization of a Roth IRA to a Traditional IRA.
Prior to using such a strategy, please see your Financial and/or Tax Advisor to decide how much should be converted and whether Roth IRAs meet your future financial objectives. Securities and advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC
Bill Sheehy is owner of Sheehy Associates Inc. which specializes in Retirement Planning for individuals and corporate 401(k) plans. He is a Certified Financial Planner, a Certified Employee Benefits Specialist, a Certified Fund Specialist and a Chartered Retirement Plan Specialist. He can be reached at firstname.lastname@example.org or by calling 609-586-9100.
Sheehy Associates. 3812-B Quakerbridge Road, Suite 208, Hamilton. 609-586-9100. email@example.com
Securities & Asset Management offered through LPL Financial, Member FINRA/SIPC.