A Brighter Way
A Brighter Way
The changing of the calendar year may signal a big change in the options you have for investing your IRA. As of January 1, anyone can convert a traditional IRA to a Roth IRA. Prior to the New Year, those with an adjusted gross income limit above $100,000 were not eligible to convert to the Roth. The tax law change also opens the Roth option to married tax payers filing separately. But making the decision to convert is still a complicated one.
Those who can afford the taxes. The conversion to Roth requires you to claim the rollover as a distribution and pay taxes on it at your marginal tax rate. This, in effect, accelerates the taxable income that you would eventually pay on the distributions from a traditional IRA once you retire.
But in exchange, you never have to pay tax on any future appreciation in the value of your account, which is often a significant tax savings. The ability to convert a traditional IRA to a Roth can be particularly advantageous to someone who can afford to pay the taxes on the converted amount from outside the IRA funds. You can choose to recognize all of the converted income on your 2010 taxes, or recognize half in both 2011 and 2012 at the rates effective for the applicable year.
Those who do not need to tap the Roth IRA during his or her lifetime. Because the Roth IRA is not subject to any lifetime minimum distributions, you can convert to a Roth and allow the funds to grow for many years on a tax-free basis. This can result in a substantial tax-free qualified Roth IRA to distribute to your beneficiaries.
A distribution from a Roth IRA must be made after a five-year holding period. However, the holding period doesn't apply if the account holder reaches age 59 1/2, dies or becomes disabled. The holding period also doesn't apply if the distribution is used for the qualified purchase of a first home.
The tax-free nature of qualified Roth IRA distributions may prevent individuals from being taxed in a higher tax bracket that would otherwise apply when withdrawing from a traditional IRA. Moreover, Roth IRAs, unlike traditional IRAs, do not affect the calculation of tax owed on Social Security payments and do not affect AGI-based deductions.
There are several considerations in making the conversion to a Roth IRA and in determining the best tax treatment if you do so. Your financial advisor can take you through the various scenarios to help you determine the most beneficial approach.
This article was originally published in Facts & Figures, Jan. 20, 2010 issue.
Note: This content is accurate as of the published date above and is subject to change. Please seek professional advice before acting on any matter contained in this article.
