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If the early announcements are any indication, 2010 could be the Year of the Roth IRA conversion. How do we know this? Well…
An August 27, 2009 article from Morningstar (news.morningstar.com) calls the chance to convert to a Roth IRA “the planning opportunity of the decade.”
In an article for the Detroit Free Press, on November 19, 2009, Susan Tompor reported “the Roth IRA conversion is definitely building buzz.”
On November 24, 2009 Forbes.com led with “Get ready to be bombarded with information about Roth IRA conversions.”
Admittedly, three sources by themselves do not make a trend, but they are representative of the general media buzz. What’s the big deal? Here’s the story:
Roth IRA retirement plans have the following features:
- Eligibility to make deposits to a Roth IRA is dependent on your income level.
- Deposits receive no tax deduction.
- Once you have held the Roth IRA for at least five years, and are at least age 59 ½, withdrawals are tax-free.
- There are no required minimum distributions from a Roth IRA at any age.
- Roth IRA assets can be left to children or other heirs.
A change in tax law, effective 2010, broadens the ability of owners of Traditional IRA accounts to convert them to Roth accounts. This is what the fuss is all about.
Beginning in 2010, the income limits on Roth IRAs will be eliminated, so investors of all income levels will be able to convert their Traditional IRA assets to Roth IRA assets. This is significant, because prior to this change, only those with a modified adjusted gross income (MAGI) of $100,000 or less could execute a conversion.
Reasons to consider a conversion to a Roth IRA
You may pay less in taxes. If you convert your Traditional IRA balance to a Roth IRA, you’ll pay taxes on the amount being converted. But because of recent market volatility, your account balance may be lower than it was when the market was stronger. In effect, you may pay less in taxes.
If you convert in 2010, you have the option to spread the tax burden over two years. When you convert to a Roth IRA, you will have to pay taxes on any deductible contributions and investment earnings. But, if you make the conversion in 2010, you can pay the taxes in 2010 or you can spread the taxes over the subsequent two year, 2011 and 2012.
There are no required minimum distributions. Unlike Traditional IRAs, Roth IRAs do not require that you take minimum distributions when you reach age 70½. That means your account can continue to grow tax-free until you – or your heirs – are ready to withdraw the money.
Reasons to not convert to a Roth IRA
Money. The Roth conversion isn’t a freebie. In order to convert to a Roth IRA, you must pay income taxes on the Traditional IRA as if you had cashed out. If you pay the tax from funds in the IRA account, it will decrease the transfer amount and diminish the tax-free growth that might occur over time. Further, if you use funds from the IRA and are younger than 59 ½, the amount used to pay the tax may be subject to an early withdrawal penalty. “A Roth conversion is expensive. There’s a big up-front cost to doing this,” Tim Steffen told Tompor. Steffen is a financial and estate planning manager for Robert W. Baird & Co. in Milwaukee.
You think you’ll be in a lower tax bracket in retirement. If your financial situation is such that you anticipate future income will be much lower than it is today, paying the tax now may not make sense.
You have a short time until you intend to withdraw the funds. Money transferred to a Roth IRA must remain in the account for five years, or it will lose its tax-free withdrawal status.
It goes back to: What’s your tax bracket?
Another twist:
What might happen to tax rates in the future? In the Detroit Free Press article, Garvey points out that the current federal income tax rates expire at the end of 2010. If Congress takes no action to renew these rates, the highest tax rate would jump to 39.6%, up from 35%. And with the deficit ballooning, it’s not unthinkable that Congress might authorize even higher marginal tax rates.
The conversion decision is “a little more art than science,” according to John Carl, president and founder of the Retirement Learning Center in Brainerd, Minnesota. “How much [in] taxes are you willing to fund now for a lifetime of tax-free income?”
IRA Help is Everywhere. To assist you in your decision, many financial companies are offering Roth Conversion Calculators on their web sites. But this is a transaction that probably can’t be decided by answering a few questions or entering some numbers in an on-line calculator. A consultation with your tax advisor is a must, as well as the financial professionals who will be handling the conversion paperwork.
