Converting to Roth IRA offers opportunity
Published 2:57 pm Friday, September 24, 2010
Since late last year, you have probably seen headlines proclaiming 2010 as the year the income limits are removed for those who wish to convert their traditional IRAs to Roth versions.
Whether those limits were meaningful to you or not, this could be a good time to convert if you believe you would benefit—and that means performing some realistic calculations.
Essentially, Roth’s appeal is two-fold: (1) qualified withdrawals—after the account has been in existence five years and you are at least 59 1/2—are free of federal income tax, and (2) there are no required minimum withdrawals.
In contrast, after you reach age 70 1/2, you must take annual withdrawals from your traditional IRAs, and you’ll pay your ordinary income tax rate on those withdrawals.
That primary difference comes about because of the manner in which the two types are funded.
Your tax break with traditional IRAs is on the front end—they are generally funded with pre-tax income—with taxes assessed on withdrawal.
Roth IRAs are funded with after-tax income, but, as noted, qualified withdrawals are free of federal income tax. The funds inside both types of retirement accounts grow tax-free over the years.
One factor currently drawing investors toward converting in 2010 is the provision, for this year only, that the income tax obligation created by the conversion can be spread equally over the 2011 and 2012 tax bills, a benefit only if your tax doesn’t rise during those years. Of course, the tax can be paid in its entirety with your 2010 return, if you prefer.
Deciding to proceed
If you believe you’ll be in the same or higher tax bracket when you need the money during retirement, if you can pay the conversion tax obligation from non-IRA sources, and if you have a suitably lengthy investment time horizon, you may be a good candidate for conversion.
You may decide to convert for estate-planning purposes, especially if you have a large IRA balance unlikely to be drawn down during your retirement. You could find satisfaction in the idea of leaving a tax-free Roth to your heirs.
Whether to convert is often complex, and every conversion situation should be evaluated on its own merits. If you would like to explore the idea further, just give me a call.
The option to spread the federal income taxes over two years applies to 2010 only. Conversions in sub-sequent years are included in income during the tax year in which the conversion is completed.
Investors should consult a tax professional about their specific situations before deciding to do a conversion.