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Too Rich for a Roth? In 2010, That's Going
to Change
Next year, individuals with a modified adjusted gross income
of more than $100,000 will be eligible to convert a traditional
IRA to a Roth IRA. The IRS is offering taxpayers a three-year
window in 2010 to pay taxes due on a conversion as part of
removing the income limits.
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 ˝ 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.
Keep in mind that conversion might be a good idea for people
in lower income tax brackets. Talk to your tax professional
about doing a full or partial Roth conversion.
Remember that when you do a conversion, you must pay income
tax on the amount you are converting. Since you received a tax
deduction on your initial contributions to most traditional
IRAs, you must pay the taxes due on those initial contributions
and any growth in your IRA. 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.
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. And the conversion option isn't
available just for traditional IRAs — it can be used for
retirement assets held at other employers and 401(k) holdings.
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 advisor such as a
CERTIFIED FINANCIAL PLANNER™ professional.
Things to consider:
How close is retirement? 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.
What will your tax rate at retirement be? 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.
Know how the conversion window will work. Keep in mind
that 2010 is the actual year you will be able to convert your
retirement assets to a Roth, but you'll be able to spread out
the tax hit. The Internal Revenue Service has granted taxpayers
the option to claim 50 percent of conversion amount as income in
2011 and the remaining 50 percent in 2012. Also, you have to
understand that if you choose the conversion period, your tax
will be based on the bracket you fit that year. That means
swings in income will affect what you pay.
November 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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