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ROTH IRA CONVERSION BENEFITS
The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) eliminates income limits and allows all taxpayers to convert traditional IRAs to Roth IRAs beginning in 2010.Roth IRAs can play an important role in retirement and legacy planning, as they allow for tax-free growth and withdrawals and are not subject to required minimum distributions during the account owner’s lifetime.
Even though the new regulations don’t go into effect until 2010, there are a number of issues to consider in 2009 in anticipation of this important change in IRA regulations.
Paying taxes is one of the biggest hurdles associated with Roth IRA conversions and understandably so. If you are dismissive of a conversion, partial conversions are permissible. This allows you to establish a Roth IRA with a conversion amount that meets your budget. And taxes due for assets converted in 2010 can be deferred until 2011 and 2012.
Converting reduced IRA balances and 401(k) balances will result in a lower tax burden while allowing those assets to recover in a tax-free account.
What if the market keeps going down and you have paid taxes on the higher account balance?
Roth IRAs come with a do-over provision called recharacterization, which allows you to convert back to a traditional IRA. Clients will receive a tax refund on any tax paid on the conversion, or the tax liability will be removed if they have yet to pay the tax.
The IRS also allows time for you and your clients to evaluate the conversion decision. For example, if a client converts any time in 2010, they have until October 15, 2011, to recharacterize. That is because recharacterization can be done up to the due date of your tax return plus extensions.
One of the principles of financial planning is deferring paying taxes for as long as possible. A Roth conversion contradicts that. And besides, Congress may change the rules again.
Tax deferral has been a cornerstone of financial planning. But this is the first time higher-income clients can take advantage of the tax-free benefits of a Roth IRA. A Roth IRA conversion is a way to diversify your client’s retirement accounts to address the uncertainty of future tax rates.
TIPRA is repealed, it is likely Roth participants would be grandfathered into the new rules. Though not guaranteed, this is typically what happens when changes to the tax code modify former tax benefits.
No one knows what taxes will be in the future, but current rates are lower than they have been in years. Given the depth of the fiscal crisis, it seems prudent to plan for an increasein federal income taxes. Rising state income tax rates will also be a factor. In addition, depleted retirement accounts will cause many people to postpone retirement resulting in more taxable income than perhaps was originally anticipated.
The foresight to fund a Roth IRA today (remember a Roth is not subject to RMD and distributions are tax-free) could make a major difference as opposed to navigating a future retirement made more challenging by higher tax rates and the need to keep working.
The potential benefits of conversion are unique to a particular individual's profile and goals,and age is certainly a factor. For older people with large estates who don’t need the traditional IRA for income, a Roth conversion may be appealing for legacy planning. Also consider that taxes used to pay conversion taxes will reduce the taxable estate and thereby the estate tax. The heirs will eventually inherit the Roth IRA from which they can withdraw tax-free income for the remainder of their lives.
Reducing the uncertainties associated with retirement always makes sense. A Roth IRA can play an important role in navigating a future made more challenging by potentially higher tax rates and the need to work
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