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2010 Traditional IRA to Roth IRA Conversion Opportunity
Starting in 2010, there are some very important changes in the tax code regarding “converting” Traditional IRAs to Roth IRAs. If in fact a conversion makes sense for you, (back to this in a moment) the long-term advantages of a Roth IRA can be quite significant, so it may be worth taking a few moments to familiarize yourself with the new rules.
Deciding whether or not a conversion is something that suits your personal circumstances will likely include weighing several variables, some of which ... like future income tax rates ... you can only guess as to their future value. So this may, or may not be a quick, simple process for you. Also, SEP-IRAs, SIMPLE IRAs, 401(k)s still held at a previous employer, may all be eligible for consideration.
If you’re contemplating the move, please consult your tax and/or investment advisor.
THE BASICS
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Traditional IRA
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Roth IRA
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Eligible for tax deductible contributions |
Contributions not tax deductible |
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Hold until age 59 1/2 |
Hold until age 59 1/2 |
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Must begin making withdrawals at age 70 1/2 |
No required minimum distributions |
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Withdrawals taxed as ordinary income |
Tax free withdrawals |
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* All items in the table are subject to certain limitations and may not hold true in your situation. The table lists the general guidelines. Please consult your tax advisor.
CONVERSIONS
Prior to 2010: Those taxpayers with incomes of less than $100,000 (in excess of that prohibited you from doing any conversions) were eligible to convert some or all of their Traditional IRAs to a Roth IRA. Any portion of the Traditional IRA converted to a Roth IRA would be counted as ordinary income and reported on the tax return for the year in which the conversion was made.
Now: The $100,000 income limitation has been eliminated. Regardless of your income, you may be eligible to convert some or all of your Traditional IRA holdings into a Roth IRA. And although any portion of the Traditional IRA converted to a Roth IRA will be counted as ordinary income, for 2010 ... and 2010 only ... you may elect to spread your tax payment over two years. Rather than paying the tax on your 2010 tax return, you can pay half on your 2011 return (due 2012), and half on your 2012 tax return (due 2013).
POTENTIAL BENEFITS
Taxes: The higher your income tax rate during retirement as compared to now, the greater the potential tax savings. Also, this past decade has been somewhat of a “lost decade” for stock market investors. The major domestic stock market indexes are at essentially the same levels they were 10 years ago. If we see a change in fortunes over the next decade or two, converting now, while market values might be comparatively low, may offer you the chance to pay taxes on an account value that’s much smaller than it may be 10 or 20 years down the road.
Long-term Growth: Since the Roth IRA doesn’t require you to begin taking withdrawals at age 70 1/2 (like the Traditional IRA requires), you can have your Roth IRA assets compound tax free for a longer period of time.
Flexibility: Since we don’t know where tax rates may be 10, 20, or even 30 years down the road, having assets in both a Traditional IRA and a Roth IRA may offer you some flexibility. As rates fluctuate, you can choose to make withdrawals from either account ... if rates are high, withdraw from the Roth, if rates are low, withdraw from the Traditional.
Estate Planning: Since there are no minimum distributions required from a Roth IRA, you may be able to let the money you intend to pass to your heirs grow without taxation for a longer period of time. Non-spouse beneficiaries of both Traditional IRAs and Roth IRAs are required to take regular distributions, however, just as with their original owners, distributions from the Traditional IRA will be taxed as ordinary income, while the distributions from a Roth IRA will be tax free.
WHEN IT MAKES SENSE
As discussed earlier, for some investors, converting to a Roth IRA may be somewhat of a calculated risk. Here are a couple of important points to consider:
If you don’t have enough money outside the IRAs to pay the tax bill, forget it, it’s not for you. Having to pay the tax bill with money from the IRAs more than nullifies any potential benefits and makes this a non-starter for you; If you expect your income tax rate to be the same as it is now or higher during retirement, a Roth might be worth considering. If you expect your tax rate to go down, the potential benefits of a Roth will likely be greatly reduced; This is not a short-term exercise. The longer you can allow the assets within a Roth IRA to compound tax free, the better chance you have of benefitting from the conversion.
As stated earlier, if a conversion to a Roth IRA makes sense for you, the long-term benefits can be quite significant. If you have questions or comments, or if you’d like to discuss your situation in a private, low-key setting, please feel free to give us a call at (407) 260-6999, or shoot us an e-mail by clicking here.
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