Advantages Abound When Converting to Roth IRA
Tuesday, December 30, 2008provided by
I want to convert my IRAs to Roth IRAs in 2009. We are retired and don't make over $100,000 a year. Could you please give me the parameters for doing a conversion? Can you spread the taxes over two years?
—John and Deborah Sellers, Hoover, Ala.
Moving assets from a traditional individual retirement account to a Roth IRA is a way to take advantage of the stock market's dive.
You do have to pay income taxes upfront on the account's value when you roll over traditional IRA assets to a Roth. But most IRA owners have seen their account balances tumble due to the liquidity crisis. And income-tax rates are relatively low at the moment as well, says Ed Slott, an IRA consultant in Rockville Centre, N.Y. So, that income-tax bill could turn out to be a relative bargain.
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Other advantages: With a Roth, there are generally no taxes on withdrawals or future earnings, unlike with traditional IRAs. There also is no mandatory distribution schedule -- again in contrast with traditional IRAs, from which account holders must begin taking minimum distributions by April 1 of the year following the year they turn 70½ years old (though not in 2009 -- more on that below). And if you're hoping to leave an inheritance, it is more advantageous for your heirs to receive a Roth than a traditional IRA, because they would never have to pay tax on Roth withdrawals.
Legislation approved by Congress earlier this month suspends retirement-account distribution requirements for 2009. That means you could roll over assets from a traditional IRA to a Roth next year without first having to take a mandatory distribution, Mr. Slott says. In other words, the taxes you pay on your IRA assets' presumably beaten-down value would all be helping you get those savings into a Roth.
And if your assets fell in value after doing the conversion, you could "recharacterize" the account as a traditional IRA so you wouldn't have to pay income tax on value that no longer exists. You would have until Oct. 15, 2010, to recharacterize a Roth you converted at any point in 2009.
As you note, to be eligible to convert traditional IRA assets to a Roth, your modified adjusted gross income must be no more than $100,000 a year, either for an individual or a married couple filing jointly. Your mandatory IRA distribution (in years other than 2009) wouldn't count against that limit, and neither would the assets you convert to a Roth. But those amounts still count as taxable income, Mr. Slott says. (You can figure out your modified adjusted gross income using a work sheet in Publication 590 at irs.gov.)
Starting in 2010 -- not next year -- there are no income limits for Roth conversions. And for any conversions done in 2010, you can spread any resulting taxes across 2011 and 2012. The big wild card: Tax rates may increase in the next few years. "Paying the tax now removes the uncertainty of what future tax rates might be," Mr. Slott says.
