By now, everyone has heard of a ROTH IRA. In case you have been hanging out with Gilligan on his island…wait, that’s showing my age…let’s try this again. In case you are on the hit show LOST and haven’t heard of a ROTH IRA, it is a retirement account (similar to a traditional IRA), but instead of getting a tax deduction for contributions on the front end and deferred income thereafter until you start withdrawing money from it at retirement, a ROTH is a retirement account where you do NOT get a tax deduction for the contribution, but afterwards get to enjoy tax free accumulation of income inside of it as well as tax free withdrawals at retirement. Since inception, there have been income limitations around who could contribute and/or convert existing tradition IRAs to Roths. For those of you who have always wanted to contribute or convert, I have GOOD NEWS (O.K., only on the convert, not the contribute portion).
Beginning in 2010, the income limitations around converting ARE GONE!!! Anyone, regardless of income, can convert a traditional, rollover (401Ks from previous employers rolled into a traditional IRA), SEP (self employed IRA), and SIMPLE IRAs to a ROTH. Before you start jumping up from your computer to call your broker, let’s first discuss who would be the ideal candidate (Remember: when you convert, you need to pay taxes on the accumulated balance of the account you are converting at your normal income tax rate). Below outlines who should (or shouldn’t) consider converting (as reported by Fidelity Viewpoints).
- You expect higher taxes in the future
If you plan to be in a higher tax bracket when you retire, plan to leave a substantial amount to your heirs, your convertible accounts are at an all time low, or you expect your 2010 income to be significantly lower, you might want to consider converting.
- You have a long investment time frame
The magic number is 10. If you have 10 years or more before you retire, you may benefit from a conversion (this is because of the opportunity for tax-free growth).
- You can pay the tax on the conversion
I alluded to this above, but with a ROTH IRA conversion, you are going to owe some taxes and the conversion is best aligned if you can pay the taxes on that conversion from something other than the proceeds. Why, you may ask? For a couple of reasons: 1). Using proceeds reduces the amount that can potentially grow tax free in the ROTH IRA, and 2). If you are under 59 ½, you will pay a penalty on the amount of the proceeds you used to pay the tax man (which, again, limits the amount that can potentially grow tax free).
If you are still with me, congratulations! You may have another incentive for converting in 2010. As long as you don’t withdraw the converted money from you ROTH before 2012, you have the opportunity to defer the tax payment over two years (keep in mind that tax rates or your income could be higher in the future resulting in a bigger than expected tax bill so please consult your CPA and/or attorney to properly plan).
While these new rules allow many people previously excluded from converting to a ROTH to convert, it requires proper planning and analysis. Please ensure that you contact your CPA and/or attorney to discuss.
About the author: Shannon Pope is a CPA serving North Houston from The Woodlands, TX to Kingwood, TX. For more information on her background and services offered, please visit the website www.shannonpopecpa.com.
The information contained herein is general in nature and provided for informational purposes only. It is not intended or provided to constitute tax or legal advice or to be used for (a) avoiding any tax related penalties that may be imposed on you or any other person/entity under the Internal Revenue Code, or (b). promoting, marketing or recommending to another person any transaction or matter addressed in this communication. Please consult with your CPA and/or attorney regarding your specific legal or tax situation. Please contact us if you with to have formal written advice on this or any other matter.
