Roth IRA Conversions: Opportunity Awaits Us

As background, back in 2006, then President Bush signed the Tax Increase Prevention and Reconciliation Act (TIPRA) into law. Prior to TIPRA, taxpayers with incomes exceeding $100,000 were precluded from converting pre-tax retirement assets into a Roth IRA. Now, in 2010, this income limit is repealed as is the restriction that precluded married couples who file separately from converting. Put simply, regardless of your filing status or how much you earn, you are now able to convert your pre-tax retirement account to a Roth IRA.  This may be good news for you for a variety of reasons. To better understand why, it is important to have a general understanding of the Roth IRA’s benefits. In general, they are are as follows:


  • Tax-free earnings, provided you follow the rules
  • Tax-free distributions
  • No required minimum distributions
  • Contributions can continue as long as you have earned income (no age limitation)
  • Estate planning (wealth transfer) eliminates taxes that would otherwise have been paid by     heirs

Let’s take a closer look at each of these five benefits.

  1. Tax-free earnings:  Earnings (growth) on your Roth IRA balance accrue without federal income taxes.
  2. Tax-free distributions: As with the traditional IRA, Roth IRA distributions need to occur after age 59½ (there are provisions for certain “qualified” withdrawals prior to 59½).  However, Roth IRA withdrawals differ from a traditional IRA in a very significant way.  Specifically, withdrawals of earnings (growth) from your Roth account are income tax-free as long as you’re at least 59½ years old and have had the account for five years, which is the current minimum holding period.
  3. No required minimum distributions: Unlike traditional IRAs and 401(k)s, Roth IRAs do not require you to take minimum distributions starting at age 70½. It is important to note that if you convert to a Roth IRA after age 70½, you will need to take one final required minimum distribution (RMD) from your traditional retirement account in the year in which you make the conversion.
  4. Contributions can continue as long as you have earned income: Another contrast to the traditional IRA is that the Roth IRA allows for contributions after age 70½ provided you have earned income. As background, Social Security and pension income do not qualify as earned income.
  5. Estate planning (wealth transfer): Because you pay the tax on your conversion or annual contributions upfront, there is no income tax for your heirs to pay on withdrawals.  This is in sharp contrast to an inherited traditional IRA, where your beneficiaries would have to pay taxes on the inherited amount. In effect, you are prepaying the taxes on future distributions that will go to your heirs upon your death.

With so many benefits for converting a traditional IRA to a Roth IRA you may be wondering, what’s the catch? You are right to wonder.  The good news is, that there isn’t any surprise other than coming to terms with the reality that you will need to pay taxes on the amount you convert. Specifically, if you make a conversion, the amount that is converted is includible in gross income. However, with respect to including the conversion amount in your gross income, there is good news in 2010. If you choose, you may push the income from the conversion into tax years 2011 (50 percent) and 2012 (50 percent). In other words, you can convert in 2010, yet you do not have to include the conversion amount in your gross income until 2011 and 2012. Of course, if you choose, the IRS will gladly allow you to report the entire conversion amount on your 2010 taxes. Regarding including the conversion amount as part of your 2010 gross income, there may be relevant reasons to do so; therefore, please consult your tax adviser.

Before making any decision and in order to make a sound decision with respect to whether you should convert your pre-tax retirement accounts (traditional IRA, SEP, and others) to a Roth IRA, it is important to consult with your tax or financial adviser.  However, prior to doing so the following are a few questions you may want to ask yourself:

  • Do I believe tax rates are going up over the longterm in this country?
  • Do I believe that my tax rate will be higher when I am ready to take distributions from my retirement accounts?
  • Do I want to reduce the tax burden on my heirs?
  • Am I interested in receiving all or a portion of portfolio earnings on a tax-free basis at retirement?

If you answered affirmatively to any of the aforementioned questions, you may benefit from converting all or a portion of your pre-tax retirement accounts (traditional IRA, SEP, and others) to a Roth IRA.

One last thought. While we all understand the benefits of diversifying our portfolios into a well thought out blend of stocks, bonds and cash, it may be prudent to consider diversifying our tax strategy as well.  In particular, the majority of investors have the bulk of their retirement assets in traditional IRAs, not in Roth IRAs. With the future of tax rates so uncertain, if you position your nest egg in accounts with different tax implications, you may be able to better mange future distributions no matter what the then-current tax code looks like. Specifically, if you have accounts that are taxable, tax-deferred and tax-free (Roth IRA), you may be able to manage your retirement cash flow in a manner which takes advantage of whatever happens with the U.S. tax structure or your personal situation.

Doug Adler and Raymond James & Associates, Inc. do not provide advice on tax, legal or mortgage issues. These matters should be discussed with an appropriate professional.

Doug Adler AAMS®, WMS is senior vice president, investments and registered principal

of Raymond James & Associates. Adler specializes in risk managed portfolio strategies and retirement planning to assist families in accomplishing their investing and personal goals.








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