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Saturday, July 12, 2008

Be Ready for Roth Conversions in 2010

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Opportunity for high-income earners to convert
By Deborah L. Jacobs
Published: July 09, 2008
If you've been shut out of a Roth IRA because of your income, 2010 is the year that you may finally be able to take advantage of these tax-free accounts. That's because in 2010 you'll be able to convert a Traditional IRA to a Roth IRA. And as an added bonus, for tax year 2010, you'll be able to spread the tax impact over the next two years, 2011 and 2012.
The time to do something may be now. You may want to contribute as much as you can to a Traditional IRA before then, so you can convert as much as possible.
The details Starting in 2010, most taxpayers -- regardless of their incomes or tax-filing status -- will be able to convert a Traditional IRA to a Roth IRA as spelled out in the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), passed in May 2006. Before TIPRA, only people -- single or married, filing jointly -- with modified adjusted gross income below $100,000 could convert.
Benefits of Roth IRAs Roth IRAs offer some benefits not available with a Traditional IRA. Taxpayers who are 59 1/2 and older can make withdrawals from a Roth IRA without paying federal income tax. And unlike a Traditional IRA, there's no requirement to take yearly minimum distributions once you reach age 70 1/2. This means your money has the potential to continue to grow for as long as you live, which may increase the amount that your beneficiaries inherit.
Sound good? Here's how to prepare.
1. Start funding Traditional IRAs. Since there are no income limits for a Traditional IRA, investors can fund one for the next three years, with the intention of converting it to a Roth IRA in 2010. The more money you have in a Traditional IRA by 2010, the more you will be able to convert to a Roth IRA, so it pays to sock away as much as possible between now and then, says Barry C. Picker, an accountant and financial planner with Picker, Weinberg & Auerbach in Brooklyn, N.Y.
While your Traditional IRA contributions may not be tax deductible -- because you have an employer-sponsored retirement plan, such as a 401(k), or your income is over phaseout levels1 -- you can still make nondeductible contributions. For 2008, anyone with earned income can contribute up to $5,000 per year if under age 50, and $6,000 if age 50 or older. (Once you reach age 70 1/2, you are required to start taking distributions from a Traditional IRA and can no longer add to the account.)
If you already have an IRA, you can simply add to it, Picker says. As long as you keep a record on IRS Form 8606 of your nondeductible contributions, there's no need to create a separate one just for this purpose.
How Fidelity can help
Open an IRA or contribute to your existing IRA.
2. Maximize contributions to qualified plans. If you are currently participating in a workplace savings plan, such as a 401(k) -- and know you will be able to roll it over into an IRA because you are leaving the company or retiring -- consider funding the 401(k) account to the greatest extent possible before then, says Ed Slott, a CPA in Rockville Centre, N.Y., and author of Parlay Your IRA Into a Family Fortune (Viking, 2005). That's because in 2010 you'll be able to roll it directly into a Roth IRA. For 2008, the limit for 401(k) contributions is $15,500, plus an extra $5,000 if you are age 50 or older.
3. Be prepared to pay tax on the Roth IRA conversion. When converting from a Traditional IRA to a Roth IRA, you will owe income tax on any taxable portion of the account balance. An important point to note: Conversions must occur on a pro-rata basis, meaning you cannot choose to only convert the portion you've already paid taxes on. For example, say you have an existing $100,000 Rollover Traditional IRA with pre-tax money. You make $5,000 in after-tax contributions to it every year from 2008 to 2010 for $15,000 in total. You'd have to pay taxes on 87% of the $15,000 because taxes are calculated as a proportion of the total of your IRA accounts ($115,000). Please consult a tax advisor to see what this may mean in your situation.
Those who convert in 2010 may have a dramatically higher tax bill in 2011 and 2012. However, if you do the conversion in 2010, TIPRA offers two additional benefits. First, you don't have to pay any federal tax on the conversion in 2010. What's more, unless you elect otherwise, and as long as the converted amounts are not distributed before 2012, half of the taxable amount will be included in income for 2011 and half for 2012. Of course, it is better not to pay those taxes with funds withdrawn from the IRA or other retirement accounts, since doing that could generate yet more tax.
4. Understand the potential estate-planning benefits of a Roth IRA. People who inherit Roth IRAs also get favorable tax treatment, so converting a Traditional IRA or workplace savings account to a Roth IRA may be a savvy estate-planning tool, notes John Ragnoni, senior vice president of retirement products for Fidelity. Non-spouse beneficiaries must take distributions over their life expectancies but, unlike with a Traditional IRA, they generally don't have to pay income tax on the withdrawals. When a spouse -- let's assume it's a wife -- inherits a Roth IRA, she also has the additional option she has with a Traditional IRA, which is to roll over the retirement account into her own Roth IRA.
5. Expect the unexpected. Two wild cards may affect planning for Roth IRA conversions. One is the prospect that Congress will raise tax rates, which would increase the toll charge for doing a conversion. The other is the prospect of a new law repealing these provisions of TIPRA before they take effect in 2010. Either way, "none of these planning techniques can really hurt you," Picker says. "The worst-case scenario is that somebody put money away into a non-deductible Traditional IRA, which is a good move anyway.
How Fidelity can help Learn more about
Roth IRAs.
(Please e-mail any comments to Investor's Weekly at

1 comment:

Angel Siribaddana said...

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