In 1997, under the Taxpayer Relief Act, the Roth IRA was born. It is aptly named after the late Senator, Mr. William Roth of Delaware, who crafted and introduced the idea. In 2010, there is a once-in-a-lifetime opportunity for those who currently own a traditional IRA. For those, it will be possible to convert traditional IRAs into Roth IRAs and receive a special one-time tax consideration. Here, in this article, I will explain this advantage and also outline who may benefit from a conversion. I know taxes are boring, but if you own sizeable IRAs and your income is expected to remain hefty, listen up.
In 2010, the maximum adjusted gross income level of $100,000 required to convert a traditional IRA, SEP IRA, KEOGH, or Simple IRA to a Roth IRA will become nonexistent. In a nutshell, this means the income level restrictions of the past, well, are in the past! They are over. Now, IRA owners can convert their IRAs to Roth IRAs regardless of income level.
In addition, if you make Roth IRA conversions in 2010, you will be given the option to pay all the taxes on the conversion in 2010 or average the taxes over two years, i.e. 2011 and 2012. Splitting the tax bite between 2011 and 2012 is only allowed in 2010. Keep in mind; if you convert a traditional IRA into a Roth IRA, you then must wait at least 5 years from the first day of the tax year in which you made the conversion before you can take a qualified, tax-free distribution. Otherwise, you will be taxed 10% as a penalty. For example, if you convert a traditional IRA on March 30, 2010, then the five-year clock starts on January 1, 2010. Capish?
Let’s talk about who may want to consider this big decision, Okay? If you are retired and know for sure you do not need IRA income, you may be a good candidate. After the conversion, your entire Roth IRA will grow tax-free, forever. Even if you leave the balance to your kids, it is all tax free, forever. If you have most or all of your savings in IRAs, and you will be living off the income stream, converting makes sense if you can wait the 5 years. This way, for the rest of your life, you will receive tax free income.
Having a tax-free source of income can help better manage your personal tax bill. Are you concerned with future income tax rate increases? With this tax and spend Presidency, we may very well be caught in such a spiral. If you are worried, converting can be an effective strategy for hedging against the risk of tax-rate increases. Another idea is this: If you have experienced severe IRA account losses, converting while account values are lower can reduce your tax bite as well.
Do you want to leave a lasting tax-free legacy to your heirs? Distributions from Roth IRAs are generally not required until inherited by non-spouse beneficiaries who receive this income tax free. These beneficiaries can opt to stretch required distributions over their life expectancy, thus preserving the Roth IRA for many, many years.
Do you have certain tax losses or deductions that you can’t use and are forced to carry forward these into the following years? If so, converting to a Roth IRA may help you by allowing these potential deductions to be used alongside your taxable conversion, thus reducing your taxes even more.
What are the disadvantages? Few, but important. A Roth IRA conversion makes sense if you live long enough to reap the tax benefit. That is why few advisors will suggest a conversion for those over age 70. If your lifespan expectations are short, then the growth of the Roth IRA after the conversion may not have a chance to occur, thus reducing the tax benefit. If you’re over age 70, and your primary beneficiary is your spouse, then it may work out well if your spouse lives to a ripe old age.
Another disadvantage is how your heirs will handle their inherited Roth IRA. Are your kids responsible? If you leave them a tax-free Roth IRA, will they let it stay invested and continue to grow? Some parents know this to be a folly. Some parents know their kids to be very astute and would say yes. You see, if you leave a Roth IRA to your kids, they get to keep it invested tax-free for as long as they live if they only withdraw a small annual sum. This sum is based on their life expectancy. If they will do this, and you’re sure of it, it may just work out well. Think about this; if your children inherit a completely tax-free sum with no penalty whatsoever to withdraw, will they really leave it alone so it may grow? If you’re not positive, maybe keeping the traditional IRA intact is your best choice. If you keep it intact and leave it to them, they must keep it invested as a Beneficiary IRA in order to receive the tax-deferred benefit.
What if Uncle Sam abolishes the current income tax structure in favor of no income tax or maybe a flat tax? If so, BOOM! Your Roth conversion plan just blew up. You guessed wrong and you paid all that tax unnecessarily. In my opinion, this is highly unlikely.
If these ideas seem confusing or you have no will power to make up your mind, just call me. A Roth IRA conversion is a smart move if all of your ducks are in a row and you plan it right. If you need assistance, call me at 321-956-7072. I will be happy to sit with you and help you with the math.
Article Source: http://www.articlesbase.com/personal-finance-articles/2010-roth-ira-conversion-1527994.html
About the Author:
Jason ValaVanis graduated from the University of Central Florida with a degree in Aerospace Engineering. He performed as an mechanical-optics engineer for Martin Merietta on the Cobra Helicopter and the F-16 Fighter Jet night vision systems. He maintained a DOD secret security clearance for his work on Military sensitive weaponry. From there, he was recruited to launch Atlas Rockets for General Dynamics at the Cape Canaveral Air Force Station. At KSC, he was a Systems Launch Engineer for 19 Atlas rocket launches and was a part of placing our GPS and military satellites in Geo-Stationary orbit. In 1990, his love for Financial Planning extracted him from the space program. With his math background, he attended college again where he completed his Professional Education Studies Program towards the coveted Certified Financial Planner Boards License. After passig the two-day Board Exam, he earned his Board Certification in Financial Planning from the College for Financial Planning in Denver. He formed two financial firms where he now manages over $85 million. His focus is simple and always remains the same: Preserve wealth while increasing income, reducing risk, reducing taxes, and creating the lifetime legacies for our loved ones. Jason is a local author where he has published over 60 articles on financial planning and facing life's money challenges. He is currently writing his first book titled: The Road to Domestic Wealth; How to Turn $50,000 into $5 million in 20 years.