Monday, March 1, 2010

Roth IRA Conversions -- Potentially Great Opportunity in 2010

You may not have a Roth IRA, since middle- and upper-income taxpayers have been ineligible for Roths due to low Adjusted Gross Income (AGI) caps ($150,000 for joint filers). You may have thought this extraordinary offer from the tax code (a tax-free investment for not only your lifetime, but the lifetimes of your heirs, as well) was unavailable to you.

Think again. In 2010, you have the opportunity to convert existing pre-tax IRAs (and, in some cases, your 401(k)) to a Roth IRA, simply by paying the income taxes now, and never paying further income taxes on the future value of the investments.

I asked a Chief Executive Boards International member, Tim Meyer of Meyer Capital Management, for a guest article on this interesting, and, depending upon your situation, potentially compelling strategy. Here's what Tim had to say:

"As part of the Tax Increase Prevention and Reconciliation Act enacted in 2006, Congress eliminated the income restrictions on Roth IRA conversions beginning in 2010. What does that mean? It means that while high-income earners still can’t contribute to a Roth IRA, they can convert a traditional IRA(s) to a Roth IRA. This opportunity might remain open indefinitely or Congress could terminate it at the end of 2010. Regardless of how long the new rule remains in effect, the way to maximize the benefit of a Roth IRA conversion is by converting sooner rather than later.

"Recall that Roth IRAs are funded with after-tax dollars (i.e., no upfront tax break). The beauty of a Roth IRA is that withdrawals taken in the future are completely tax-free and there are no required minimum distributions. The absence of required minimum distributions makes Roth IRAs attractive estate planning vehicles for those who don’t expect to need their IRA funds in retirement.

"CEBI members would do well to take a close look at the 2010 Roth IRA conversion opportunity. Here are some of the key issues to consider:

  1. Your age, health, & likely life expectancy -- These variables determine the length of your investment time-horizon following Roth conversion. The longer the time-line, the better off you are since more time allows the benefits inherent in the Roth IRA to accrue. For example, if you’re under 60, Roth conversion may make sense. Consider, also, that Roth IRAs remain tax-free and have no Required Minimum Distributions for beneficiaries. Regardless of your own age, passing on a Roth to heirs may be a valuable estate-planning tool, stretching the potential tax-free investment time horizon for decades.

  2. Your expected effective tax bracket in retirement -- This is a function of your income level in retirement and the structure of the tax brackets themselves at that time. Like #1 above, these variables can’t be known with 100% certainty, but they can be estimated. If you expect to be in a comparable or higher tax bracket in retirement than you are now (potentially driven by IRA Required Minimum Distributions), Roth conversion may make sense.

  3. Do you have the funds outside your IRA to pay the conversion taxes? If you convert, you have to pay income taxes on the money coming out of your traditional IRA. Prior to the tax law change, you’d have to pay all the conversion tax in the year you convert. Congress sweetened the 2010 conversion opportunity by allowing you to 1) delay declaring the conversion income, and 2) split the tax payment between the 2011 and 2012 tax years. Be mindful that 2011 and 2012 tax rates will apply to this option. When the taxes come due, pay them out-of-pocket. Using IRA money to pay conversion taxes reduces the net amount converted, which, in turn, reduces the conversion benefits proportionately.

"Given the uncertainty of some of these issues, an additional option to consider is to do a partial Roth IRA conversion. This strategy recognizes that none of us can know how long we will live or what our effective tax rate will be years from now. Therefore, a partial Roth conversion constitutes a hedging strategy -- you convert some IRA assets and leave some alone. If the window remains open, you may want to do further conversions in future years.

"In general, the Roth conversion offers a unique opportunity for otherwise ineligible investors to accumulate tax-advantaged assets for retirement and estate planning purposes. Deciding whether or not to convert, both partially or in full, can be tricky and requires the assistance of a qualified, trusted tax expert.

"Once the decision to convert is made, a good investment advisor can execute the conversion. Be aware, however, that some unqualified financial professionals see the Roth conversion process as an opportunity to make money for themselves rather than their clients. Respected personal finance columnist, Kathy Kristof, blows the whistle on unscrupulous predators masquerading as financial planners or wealth advisors in her recent article
Crooks Are After Your Retirement Plan. I urge you to take a few minutes to read it and protect yourself."

Thanks, Tim, for an excellent article. To our readers -- this isn't a simple question, although it could be potentially valuable to you. It's counter-intuitive to pay taxes now that you don't have to. Yet it may be in the best interest of not only yourself but generations of future heirs. Don't dismiss this opportunity out of hand, without doing the math to see if it might be useful to you.

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

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