Now is an ideal time to become familiar with the benefits and drawbacks of converting a traditional IRA to a Roth IRA. Currently, only households with a modified adjusted gross income (MAGI) of less than $100,000 can convert, but this income limit will be waived in 2010. Consider these key factors to determine if this strategy is appropriate for your circumstances.
Why Convert?
Before converting your traditional IRA into a Roth IRA, ask yourself whether you anticipate being in a lower, higher or the same tax bracket during retirement? If retirement withdrawals or other sources of income will keep you in the same or higher tax bracket, why not pay taxes on your retirement account now so you can enjoy the benefits of a lower tax rate? This is exactly what a Roth conversion allows you to do. Here are three more tax implications to consider:
1. Tax rates are incredibly low by historical standards. Most experts anticipate tax rates to increase in the near future to allow the government to fund liabilities such as Medicare, Social Security, and the economic stimulus package. If rising tax rates are a concern, why not convert a traditional IRA to a Roth, pay taxes at today’s low rates and enjoy tax-free growth going forward?
2. Converting now, after asset values have dropped 40%, will minimize taxes. Investors will only pay taxes on today’s deflated values, which is more cost-efficient than paying taxes on 2007 investment values.
3. The government does not require minimum distributions from Roth IRA accounts. This enables money to continue to grow tax deferred for as long as possible. At death, a Roth IRA transfers to heirs tax free; a traditional IRAs does not.
Other Factors
Investors who convert in 2010 have the option of splitting the tax bill between 2011 and 2012. When converting, ALWAYS pay the tax liability with other income to keep as much money growing tax-free as possible. Lastly, be conscious of IRA conversion distributions lifting you into a higher tax bracket. An investor can partially convert an IRA during multiple years to avoid a large infusion of income in a single year. Continue reading ‘Is a Roth IRA Conversion Right For You?’ »