In 2010, anyone may convert a traditional IRA to a Roth IRA. No income limits will stand in the way of the conversion. Should you do it? Here’s why it may (or may not) make sense for you to go Roth next year.
Why you might want to consider it. A Roth IRA permits tax-free growth and tax-free income distributions in retirement (assuming you are age 59.5 or older and have held your Roth account for five years or longer). You can contribute to a Roth IRA after age 70.5, without having to take mandatory withdrawals. While contributions to a Roth IRA aren’t tax-deductible, the younger you are, the more attractive a Roth IRA may seem.
However, older investors have reason to go Roth as well – especially if they don’t really need to withdraw IRA assets. Under present tax law, converting an untapped traditional IRA to a Roth will shrink the size of your taxable estate, and careful estate planning could foster decades of tax-free growth for those IRA assets.
Currently, if you name your spouse as the beneficiary of your Roth IRA, your spouse can treat the inherited IRA as his or her own after you die and forego withdrawals. So those Roth IRA assets can keep compounding untaxed across the rest of your spouse’s life.
If your spouse then names a son or daughter as a beneficiary, that heir has the choice to make minimum withdrawals according to his or her life expectancy, all while the assets continue to compound tax-free. Currently, withdrawals from an inherited Roth IRA are not subject to income tax.
Why you may want to think twice about it. The IRS regards a traditional IRA-to-Roth IRA conversion as a distribution from a traditional IRA – a taxable event. You will need to pay taxes on the entire amount of the conversion. Do you have the money to do that?
Keep in mind, however, with the market down, many IRA values are lower than they have been for years. That translates to paying less tax on gains. It is also worth remembering that tax rates could increase in the years ahead – another reason why now may be a good time to convert. (You could simply do a partial Roth IRA conversion if converting the full amount would send you into a higher tax bracket. Furthermore you can choose to divide the taxes on the conversion done in 2010 between your 2011 and 2012 federal returns.
Be sure to consult your financial planner and tax advisor before you convert. This is a very good idea before you arrange any rollover, trustee-to-trustee transfer, or same-trustee transfer of your IRA assets. In any year, you should fully understand the potential tax impact of a Roth conversion on your finances and your estate. Also, remember that while the income limit on Roth IRA conversions will go away in 2010, the income limits on Roth IRA contributions still apply next year and for the foreseeable future.
David Weible is a Certified Financial Planner™ and President of Envision Wealth Management, a Registered Investment Advisor, located in Valencia. He can be reached at 661-291-2500 or via email at envision.wealth@lpl.comThis email address is being protected from spam bots, you need Javascript enabled to view it .