Roth IRA conversions available – but beware
Lance Fenton
Usually when Washington gives you a tax break with one hand, they take something else away with the other, leaving you to decide which is better. That’s certainly the case with new rules making it easier to convert your regular IRA account to a Roth IRA. This could be a great opportunity for you, but it’s not a slam-dunk.
Why is this such a hot button this tax season? The revision is somewhat complicated and it can be used as an after year-end tax planning tool because you can contribute to your IRAs until April 15 and still capture benefits for your 2009 taxes. This article is just to let you know that this change is here and to help you decide if you should investigate it further.
Under current law, there are two kinds of IRAs. The regular IRA lets you deduct contributions today and defer tax on your funds until you withdraw them. The Roth IRA, on the other hand, offers no up-front deduction but allows you to take money tax-free during retirement. And there are no required minimum distributions as with regular IRAs.
Prior to 2010, you could convert your regular IRA to a Roth IRA, if your income was under $100,000. However, as of Jan. 1, 2010, you can make the conversion regardless of how much money you earn. What’s the catch? You have to pay the tax on the full amount you convert now by either splitting it up into 2011 and 2012 or paying it all at once in 2010.
If the tax you pay to convert today is less than the tax you would pay to withdraw the money tomorrow, it makes sense. But deciding isn’t as easy as you might think – who knows where tax rates will be tomorrow?
Even calculating the actual tax you’ll pay to convert today is harder than it looks. You can’t just assume that you’ll pay your regular marginal rate. That’s because you take the full amount you convert and add it to your total income. And that has ripple effects to consider, such as phasing out itemized deductions and personal exemptions, subjecting Social Security benefits to tax – not to mention putting yourself into a higher tax bracket.
In addition, these new Roth IRA conversion provisions may even pose benefits for conversion of monies held within certain qualified retirement plans.
Bottom line: This is not a do-it-yourself calculation. So if you’re curious about this opportunity at all, don’t make an expensive mistake you can avoid. Contact a tax adviser for details.
Lance Fenton is a certified public accountant and partner in charge of the Boise office of Cooper Norman Certified Public Accountants.
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February 3rd, 2010 at 7:40 pm
Generally, it’s best to invest in a 401(k) up to the employer’s match — otherwise you’d be passing up free money. But if your employer doesn’t offer a matching contribution, go with a Roth IRA first.
But before you invest in any retirement plan, make sure you have three to six months worth of living expenses saved in an emergency fund, and you’ve paid off your high-interest debt.
This should also help you:
http://www.rothirarules.net
(basic Roth IRA do’s and don’ts)
September 14th, 2010 at 9:59 pm
There’s also a misconception in people’s minds that in order to pay the conversion taxes they owe in 2011 and 2012, they can make extra withdrawals from their old traditional IRAs (that are now Roth IRAs) to be able to meet tax obligations… This is misleading totally! Consider this example from http://www.definerothira.com
Note: There is a misconception that some of the converted funds to the Roth IRA can be used to pay for federal taxes owed on the conversion. In the case of Peter, the $12,500 in taxes that he owes; he might think he can take out $12,500 from his $50k conversion to be able to pay for the federal taxes. Do NOT do this! If you do this, you will be taking an early withdrawal penalty and will be assessed a 20% early withdrawal penalty on the $12,500 withdrawn. In summary, Peter should have set aside an additional $12,500 to pay for the federal taxes, aside from his $50,000 conversion to Roth IRA.
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