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One Good Thing about a Tough Market, It's a
Good Environment for Roth IRA Conversions
Most of us will not start the New Year happy about our
investments. But if you are looking for a bright spot, it's not
a particularly bad time to consider converting a traditional IRA
to a Roth IRA.
Right now, anyone with modified adjusted gross income of less
than $100,000 a year (individual or joint income) can convert a
traditional IRA account to a Roth IRA. Higher-income Americans
will get the same break in 2010 if Congress doesn't reverse its
2006 approval of provisions in the Tax Increase Prevention and
Reconciliation Act of 2005 (TIPRA).
Keep in mind that this also might be a good idea for people
who were also unemployed or disabled during the past year and
therefore had lower income. Talk to your tax professional about
doing a full or partial Roth IRA conversion.
Remember that when you do a conversion, you must pay income
tax on the amount you are converting, which can be all of the
funds in the traditional IRA or just a portion of those assets.
But, subject to certain restrictions, you won't pay tax when you
finally need to withdraw your money. That's where the silver
lining comes in for you or for your heirs if you pass that money
on to them.
Take another look at your statements and how much your
investments are down. Assuming that the markets perform
historically and fight their way back, your tax-free amount
available for withdrawal could accumulate significantly under
that Roth status.
The conversion issue is a potentially attractive retirement
and estate-planning idea for all Americans who want to make sure
they maximize the assets they have for themselves and for their
heirs on a tax-free basis. But anyone considering such a move —
regardless of his or her income status — should first review
their current retirement asset strategy with a tax or financial
adviser such as a CERTIFIED FINANCIAL PLANNER™ professional.
Things to consider:
The difference between a traditional IRA and a Roth IRA.
Traditional IRAs allow investors to save money tax-deferred with
deductible contributions (within certain income limits if either
spouse is eligible for a qualified plan at work) until they're
ready to begin withdrawals anytime between age 59 ˝ and 70 ˝.
Roth IRAs don't allow tax-deductible contributions, but they
allow tax-free withdrawal of funds with no mandatory
distribution age and allow these assets to pass to heirs
tax-free as well. If you leave your savings in the Roth for at
least five years and wait until you're 59 1/2 to take
withdrawals, you'll never pay taxes on the gains. You can
convert a traditional IRA to a Roth, but you must pay taxes on
any pre-tax contributions, plus any gains.
Time to retirement matters. If you have more than five
years until you plan to withdraw your retirement funds,
conversion of traditional IRA assets to a Roth IRA might make
sense. The longer the time span where earnings can grow tax
deferred, the greater the benefit of being able to withdraw
those earnings without paying tax on them.
Your tax rate at retirement is important. Many people,
such as business owners, may be paying taxes now at a fairly low
rate. So they might pay higher taxes at retirement. If that's
the case, converting to a Roth might make a lot of sense.
Additionally, with Social Security benefits being taxable at
certain income levels, Roth IRAs can allow you to limit or
eliminate such taxes.
A Roth conversion can be expensive. You'll have to pay
taxes on contributions that you previously deducted, as well as
taxes on the accumulated earnings. Also, you need to be aware
that conversion could push you into a higher tax bracket,
especially if you've accumulated sizeable earnings over the
years. This is why a conversion needs to be planned with a tax
expert. Why? It may trigger the Alternative Minimum Tax (AMT)
due to those high earnings.
January 2009 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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