Never before has there been such hubbub over the benefit of converting your traditional IRA account to that other tax-friendly alternative known as the Roth IRA.
Unless you haven't heard, there has been a certain magic associated with Roth retirement accounts since they allow money that has been set aside for retirement to grow tax free. Better yet, when the money is pulled out it is still tax free - whether you take it out during retirement or your kids do so as your beneficiaries.
In recent months, the Roth conversion strategy has grown in popularity among financial advisers who hasten to remind you that, starting in 2010, new planning opportunities are available, including an open-door policy that allows everyone to make the switch.
That's right - even big-time earners are now qualified to convert to the tax-friendly Roth.
The Roth IRA (and its lifetime insulation from taxes) is particularly attractive if you expect that you will be paying higher taxes in the future during retirement. Moreover, there are many who are convinced that, in view of the way our economy is headed, tax rates can only be headed upward.
The downside? As you probably know, a Roth conversion requires that you ante up the taxes up front on the amount being converted.
Traditional vs. Roth
Experts have long argued that under the bird-in-hand theory it is a waste of time and money to try and beat the economic advantages of the traditional IRA. Why not get your tax write-off now when it really matters, they query, rather than later?
Under this argument, you may be wondering why anyone would bother to make a Roth conversion and pay a tax bill up front - only to gain a (hard-to-define) tax benefit at some unknown time in the future.
Under this prevailing mind set, most retirement planners have been reluctant to dip into their non-IRA holdings to pay any taxes whatsoever, especially during these troubling times.
What's so special about 2010? In addition to the newly relaxed rules for eligibility, there are several other reasons why you might want to check to see if you could turn out a winner by making the Roth conversion - notwithstanding the so-called bird-in-hand logic.
Most important, during 2010 you may have the opportunity to gain:
A low market value planning opportunity. Many IRA owners who have been ravaged by the market meltdown of 2008 will find it especially advantageous to convert this year. For them, there will be a relatively small tax cost on the depressed value of their investments at today's favorable tax rates.
And (if qualifications are met) any future rebounds in the market will be unscathed by taxes, regardless of how much the government will increase the tax rates later.
An option to postpone the payment of the tax on the conversion. For 2010 only, you can decide if you wish to report the income from the conversion this year. If you prefer, you can report half the 2010 income on your 2011 return and the other half on your 2012 return at the tax rates in those years - clearly an important advantage for many.
Ideal candidates for a Roth conversion in 2010: The best candidates are individuals who expect that their tax bracket will be the same - or, perhaps, will increase - during retirement years. Particular attention is directed to those who expect an especially down year (income-wise) during 2010.
However, it also includes all those young individuals who have high income potential. There are also great planning opportunities for the wealthy and those who seek to reduce estate settlement costs. But above all, a Roth conversion should only be considered by those with adequate cash reserves on hand to pay the tax bill up front without having to draw out of their retirement account.
Crunch the numbers first: Regardless of your goals, you need to be clear as to what your up-front tax cost will be if you are considering a conversion in 2010. Even the experts can't rely on a rule-of-thumb calculation under the current tax rules.
You (or your tax professional) should run the figures through a tax software program - or make the calculation applying the existing variables in the tax law.
Planning tip: If you are on the fence with your decision, you might want to consider an (inexpensive) compromise since it's not an all-or-nothing proposition. You are allowed to convert any portion of the balance of your traditional IRA, so try a cherry-picking strategy.
Convert only those that took a nosedive with the economic downturn but have a good expectation of recovery. The tax cost could be minimal this year, but the potential tax savings down the road could be a bonanza for you, or your heirs.
As always if you have any questions or comments please email me at rondazaragoza@gmail.com. I will try and reply to your question within 24-48 hours of receipt.
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