This year, the rules surrounding conversions of traditional IRA money to a Roth IRA are changing. As the law currently stands, only individuals with a modified adjusted gross income (MAGI) of $100,000 or less can convert traditional IRS dollars to a Roth. The 2010 change eliminates the MAGI limitations meaning that most taxpayers will be eligible to convert their traditional IRA to a Roth. This change provides a potentially powerful new tax planning option that should be considered by all who qualify.
Keep in mind however, considering and doing are two very different things …and although you can, doesn’t necessarily mean you should…so taxpayer beware and make sure you do your homework and get a professional opinion before making any final decisions about this tempting Roth IRA conversion opportunity.
The Basics: As you probably know, the contributions to a ROTH IRA are not tax deductible, however your investments grow income tax free…and, if you keep your money in the account for a minimum of st five years and you are at least 59 1/2 years old, all of your distributions of earnings are also income tax free. As an added bonus, distributions are also not subject to the required minimum distribution rules at the age of 70 ½ like the traditional IRA.
What’s Happening: Through 2009, a taxpayer could not convert from a traditional IRA to a Roth IRA, if your MAGI is over $100,000. Beginning in 2010 and beyond, that limitation is abolished. And, in addition, there is a special rule in place for 2010 only that will allow a taxpayer to recognize 100% of the
conversion income in 2010 or split it equally between the next two tax years, 2011 and 2012.
And that’s the dilemma. Should you convert your traditional IRA to a Roth and pay the tax now, or should you just keep it in a traditional IRA and pay the tax as you distribute the money down the road?
The answer is quite simple, actually…it depends!
Even though you have to pay current income tax on the amount you convert to a Roth, it still may make sense if:
- You think you will be in the same or a higher tax bracket when you withdraw the funds.
- You have a long time horizon, and
- You have the money to pay the tax with non-retirement funds (to eliminate paying tax on the tax) or
- You don’t need to use the money and want to leave it to your heirs income tax free as an estate or gift tax planning device.
The “rule of thumb” in our office has been, if you are a high net worth individual, concerned about the issue of estate tax, it probably makes sense to convert since you are not only eliminating the income tax burden at the time of death, but also your estate is being relieved of the “income tax” dollars you paid in terms of the gross estate calculation.
If the estate tax issue is not your concern…the 2010 conversion is not as crucial and you probably would not go wrong passing on the opportunity and “rolling the dice”.
As always, if you need an professional opinion, you are welcome to give us a call.