2010 Roth Conversion:
To Roth Or Not To Roth
[2010]
Beginning this year the rules surrounding conversions of traditional
IRA money to a Roth IRA have changed. The 2010 change eliminates
the modified adjusted gross incomes (AGI) of $100,000, meaning most
investors would be eligible to convert their traditional IRA to Roth
IRAs.
But just because you can convert to a Roth IRA doesn’t necessarily mean
that you should. Let’s do a brief recap of the basics:
Roth IRA vs. traditional IRA
Traditional IRA:
Money put into a traditional IRA is tax-deductible no matter how much
money you make, unless you’re covered by a qualified employer-sponsored
retirement plan like a 401 (k), in which case you may receive a reduced
deduction (or no deduction at all) for the contributions made to your
IRA.
Roth IRA:
With a Roth, contributions are not tax-deductible, but earnings can be
withdrawn income-tax-free if you’re at least 59 1/2 and have had the Roth
at least five years. And you don’t need to take required minimum
distributions (RMDs) starting at age 70 1/2, as you do with a traditional
IRA.
So if you qualify for both a deductible traditional IRA and a Roth IRA,
which one makes the most sense? Even though you have to pay
current income tax on the amount you convert to a Roth IRA, it might
make sense to convert if:
(X) You think you will be in the same or a higher tax bracket when you withdraw,
(X) Have a long time horizon, and
(X) Can pay the tax from sources other than your IRA, such as from regular taxable brokerage or bank accounts.
Or
(X)
You don’t need to use the money and want to leave an income-tax-free
Roth IRA to your heirs for gift and estate-planning purposes.
Who most stands to gain by the change in 2010? Remember, the
primary reason for the rule change was to accelerate the collection of
income taxes that might have otherwise been locked up in traditional
IRAs for decades to come. That doesn’t mean it still can’t be a
good deal for certain taxpayers under the right set of facts and
circumstances. But, who is most likely to gain from Congress’
“generosity” (besides the US Treasury)? For those with
incomes between $100,000 and $250,000, the newfound eligibility for a
Roth conversation might be worth a look. Converting part or all
of a traditional IRA to a Roth is advantageous for estate-planning
purposes. The income tax paid at the time of conversion
(preferably from assets other than the IRA) will reduce the owner’s
gross estate. In effect, the account owner is prepaying income
tax on behalf of future beneficiaries without it really counting as a
taxable gift. It could be a hedge against potential future tax
increases and provide tax diversification in retirement. In
certain situations, it may be beneficial to defer the income tax
liability and split the tax between your 2011 and 2012 tax
returns. However, this can be an expensive mistake if not
examined carefully.
The bottom line - Eligibility for a Roth conversion doesn’t
automatically make it a good idea. Each situation needs to be
evaluated on a case-by-case basis. If you are considering a Roth
conversion, give us a call. We will help you identify your needs
and goals, consider your options, and determine if a Roth may or may
not be right for you.
Contact our office if you have any questions about Roth IRAs.
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