Is
it time for you to consider a Roth Conversion?
Through
the years we have often touted the benefits of Roth IRAs to Beacon
clients and suggested financial planning strategies for utilizing
Roth IRAs. Given the current economic conditions and likelihood of
rising income tax rates, we believe that everyone who qualifies
should consider a Roth conversion this year.
A
Roth IRA refresher
Before
considering the merits of a Roth conversion, it is necessary to
discuss the benefits of Roth IRAs in general. The following are
several advantages of Roth IRAs:
-
Qualified
distributions from Roth IRAs are not subject to income tax (as they
are with 401(k) plans and traditional IRAs).
-
Investment
earnings are completely tax exempt.
-
There are no required
minimum distribution (RMD) requirements at age 70 1/2, allowing
these accounts to grow tax-free indefinitely.
-
Original Roth
contributions, including conversions, can be withdrawn prior to the
age of 59 ½ without penalty.
When
is a Roth Conversion Appropriate?
For
2009, only taxpayers who have a modified adjusted gross income level
below $100,000 are eligible to make Roth conversions. With that in
mind, here are several scenarios that may present a perfect
opportunity for a Roth conversion.
You are over the age of 70 1/2 and normally take required
minimum distributions (RMDs)
As a
result of battered investment portfolios, Congress decided that in
2009, required minimum distributions from IRAs should be suspended.
So, for those taxpayers who do not need their IRA to fund living
expenses, it may make sense to take an IRA distribution anyway. IRA
holders can pay taxes on the distribution and convert the IRA
proceeds into a Roth IRA.
Most
brokerage firms (including Schwab) allow their clients to simply move
shares of a stock or mutual fund directly into a Roth IRA to
facilitate the conversion. By transferring an investment directly,
at depressed values, you would essentially have transferred (and paid
the taxes on) a depressed asset with the thought that you, or your
heirs, would never pay taxes on that investment again.
You temporarily expect to be in a lower income tax bracket in
2009
For
many, 2009 will prove to be a year in which income levels decline.
In some cases, high income earners have been laid off or have taken a
significant pay cut. Suddenly, they may find themselves in a much
lower tax bracket.
For
people in this category, converting an IRA to a Roth could
essentially allow normally high-bracket taxpayers to maximize the
lower tax brackets in a low earnings year.
There is a possibility that you will have unused itemized
deductions
Some
people find themselves in a situation where they have sizable
itemized deductions, but their income is so low that some of these
deductions go unused. Examples could include, high medical expenses,
mortgage interest, property taxes or state income taxes.
For
these taxpayers, it may make sense to convert a portion of their IRA
into a Roth. This tax planning strategy essentially creates
additional income, which enables the taxpayer to make full use of
their itemized deductions. Additionally, taxable IRA proceeds are
then converted to a Roth IRA and never taxed again.
2010
Roth Conversion Opportunity
In
the past, only those taxpayers with an adjusted gross income of
$100,000 or less were able to convert existing IRAs into Roth IRAs.
Congress has suspended the adjusted gross income limitation for Roth
conversions for the year 2010. As such, taxpayers at any income
level have the ability to convert their IRAs into Roth IRAs. While
this may represent a golden opportunity for some, there are a number
of issues to consider prior to making the switch including the
following:
-
What will be the tax cost for the conversion?
-
Will the additional taxes from the Roth conversion be paid from the
conversion itself, through paycheck withholdings or through other
means?
-
Will a Roth conversion create adverse tax implications like the
deductibility of medical expenses or increased costs of Medicare
Part B premiums?
-
Does
it make sense to execute a Roth conversion
into multiple Roth accounts, to take maximum advantage or the
possibility of recharacterizing the conversion at a later date?
We
believe that tax rates are likely to rise somewhat
over the next decade. Executing a Roth conversion now, while tax
rates are low, can represent a significant future tax savings to you
and your family. Of course, every situation varies so it is
essential to fully consider the tax and non-tax implications when
converting IRA proceeds into a Roth.
If you would like to
discuss the pros and cons of a Roth conversion given the details of
your specific situation, please feel free to contact us to schedule
an appointment.
About
Beacon Financial Strategies
Beacon
Financial Strategies is an independent, fee-only financial planning,
tax and investment advisory firm located in Raleigh, NC. Beacon works
with clients on a consultative and objective basis to help them
achieve their personal financial goals. Beacon professionals
specialize in the following areas of financial planning: retirement
feasibility planning, estate planning and coordination, investment
management, tax minimization strategies, and other wealth management
services. Feel free to contact us for more information.