Charlotte Women's Magazine - December 2009
Roth IRA and the 2010 Conversions
Several articles have been written about the new rules for Roth IRAs in 2010. Let’s take a closer look at what the discussion is all about and if converting your IRA to a Roth IRA is right for you.
What is the advantage of a Roth IRA? With a traditional IRA, you are required to withdraw a minimum amount each year after reaching age 70 ½ and the distribution is fully taxable. By using a traditional IRA, you get a tax break when you make the contribution and the earnings grow tax deferred. When making contributions to a Roth IRA, no taxes are saved when the contribution is made and no taxes are paid as the money grows. The distribution from a Roth IRA is not taxed, unless you are less than 59 ½ or the money has not been in the account for at least five years.
Who are the best candidates for Roth IRA conversion? Those who had the value of their traditional IRA decrease and expect future tax rates to be higher. Through 2009, only those with Adjusted Gross Incomes below $100,000 are allowed to make the conversion. Starting in 2010, all individuals are eligible to make the conversion regardless of their income.
Some taxpayers that covert a traditional IRA to a Roth IRA will pay as little as 10% income tax. The current maximum tax rate is 35%. For example, if a person converted $20,000 from their traditional IRA to a Roth IRA, the taxes generated could be $2,000 (in some situations, even less). At the maximum tax rate, $7,000 in taxes would be generated.
What if you change your mind or what if you make the conversion and the market declines 25%? A cure is available. You have until October 15th of the year following the conversion to recharacterize the contribution effectively reversing your earlier decision.
There are several decisions to make and converting money from a traditional IRA to a Roth IRA is not for everyone. The income tax as a result of the conversion should not come from your IRA balance. Not everyone has the resources to pay the tax outside of their IRA. If you are taking a required minimum distribution (RMD) from your IRA each year, those dollars cannot be rolled into a Roth IRA.
For those making a conversion in 2010, the taxes can be spread out evenly over 2011 and 2012. Currently, the tax deferral is only available for conversions made in 2010. You still have the option of paying all of the taxes due in 2010.
Remember, the money must stay in the Roth for five years after making the conversion. Making the decision is a personal choice. Individuals should consult their investment advisor and tax professional to help them with their options and consequences.
Your investment advisor and tax professional can also provide information about making traditional or Roth IRA contributions for the 2009 year. You have until April 15, 2010 to make your 2009 IRA contribution. Not everyone is eligible to make tax deductible IRA contributions or Roth IRA contributions. A contribution to a traditional IRA will reduce your taxes, but you will pay taxes on the money when you withdraw it. You will not receive a tax deduction for a Roth IRA, but the money will grow tax free and the distributions from a Roth IRA will be tax free if you are over age 59 ½ and the money was in the Roth IRA account for a minimum of five years.
As 2009 is winding down, it is a good time to take a final look to make decisions that will affect your 2009 income and expenses for the calendar year.