The 2010 Roth IRA Opportunity
Since its addition to the tax code in 1998, many have wanted to take advantage of the benefits of contributing to a Roth IRA.
What is a Roth IRA? Most of you are likely familiar with the way a Traditional IRA operates. It is similar to your 401k or other retirement plans at work: money goes into the plan pre-tax (saving you some money today), defers taxes during growth, and creates taxable income upon withdraw.
A Roth IRA is similar to a Traditional IRA except that you contribute taxed dollars and the money can come out income-tax free (saving you money in retirement). An IRA is putting money in pre-tax and getting what that turns into as taxable income during retirement. A Roth IRA is taking money that has already been taxed so that your withdrawals are tax free.
Why is 2010 an important year? In 2010, converting your Traditional IRA to a Roth IRA will become more attractive and more accessible than ever since the Roth IRA's inception in the late 90's.
Current regulations prevent individuals and couples earning more than $100,000 from converting their IRA to a Roth. For those who are eligible, taxes on the full transfer must be paid at the conclusion of that tax year.
Next year, regardless of income, any individual will be permitted to convert their IRA to a Roth IRA. This is generating a lot of interest with higher income clients because they typically have little to no money saved in a Roth IRA. By converting, they will be able to shift the taxable income generated by a Traditional IRA to potentially tax-free income generated from a Roth IRA. By having funds in both types of IRA's, clients can better control their income taxes during retirement, avoid taking a distribution at age 70½ from their Roth IRA's, and transfer assets tax-free to their heirs.
The good news for anyone who wants to convert in 2010 is that the taxes on the amount converted will be spread out with half being due in 2011 and 2012.
Does a conversion make sense for me? Cautions - remember that just because you can, doesn't mean you should. You need to make sure that you can pay for the income taxes in 2011 and 2012. If you can’t afford the taxes, then this doesn’t make sense for you.
There is a five-year waiting period that must transpire before you can access your principal without a penalty. Additionally, you must be at least age 59½ before you can withdraw gains in your account without incurring a 10% penalty.
Even if you wait the five years and have reached age 59½, you may still have to wait a few years (or more) before the cost to convert has been made up by gains in your Roth.
Benefits - unlike a Traditional IRA, there are no mandatory withdraws to be made after age 70½. This means you can continue to allow the account to grow tax-deferred for as long as you’d like. Because the account distributions are tax free, the Roth IRA makes a great tool for estate planning. Your partner or other heir(s) can receive the money income-tax free (not estate tax free, however).
One of the most popular reasons for using the Roth IRA is to provide tax control during retirement. Using the Roth IRA to compliment your other retirement accounts, you may be able to take enough income from each source to minimize your income tax bracket thus reducing your taxable income during retirement.
Remember to speak with a tax professional and your financial advisor to evaluate your options before making a decision. This won’t work for everyone, but is important enough for everyone to weigh their options.
This article is for informational purposes only and is not intended to provide specific advice to any individual. Consult your legal, tax, and/or financial advisor to determine what is appropriate for your situation.
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