News & Events
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June 2010
2010 - Year Of The Roth IRA
by Jack S. Johal
As many of you know, the current income limitations on converting a traditional IRA to a Roth IRA will be eliminated in 2010. Currently, a conversion is limited to households with incomes less than $100,000. The change will open the door for millions of current IRA holders to consider a switch from a traditional IRA to a Roth IRA. The income limitations for regular funding of a Roth IRA will remain in place. Only the rules for converting from a traditional IRA to a Roth IRA have changed.
Why change? Here are some of the advantages of a Roth IRA:
- Unlike traditional IRAs (where you receive a deduction for contributions, but not withdrawals), withdrawals from a Roth IRA are tax-free, assuming you have held the Roth for at least five years and are age 59-1/2 or older. Early withdrawals are subject to a tax penalty.
- There are no required distributions from a Roth unlike traditional IRAs where distributions must be taken after age 70-1/2.
- You can bequeath a Roth IRA to heirs, who can make tax-free withdrawals over their lifetime.
Unfortunately, there is a significant cost to the conversion – paying the income tax due on the amount that you convert. The conversion is considered a taxable event by the IRS; however, during 2010, you can report the amount you convert on your tax returns for that year or you can report the amount equally on your 2011 and 2012 tax returns.
Deciding whether to make a conversion, and if so, how much to convert, may depend on your estimate of what may happen to tax rates in the next few years. The Obama administration has indicated that they will let the Bush-era tax rates expire and return to previous levels. That would take the current top income tax rate from 35% to 39.6%.
Some commentators have also speculated that income tax rates may increase even further in the future to pay for the significant underfunding of other government programs such as Medicare and Social Security. Certain cynical commentators have also suggested that the “tax-free” benefits of the Roth IRA may someday be taxed at least for higher-income individuals. They point to Social Security and Medicare as examples of programs that have been modified based on a recipient’s income.
Another factor to consider is how you would pay the income taxes due on any conversion. Most analysts argue that paying the tax from the proceeds of the traditional IRA offsets much of the gain from the conversion to a Roth IRA. Taxes should be paid from other resources, if possible.
If you do decide to make a conversion, it is recommended you consider opening a new, separate account rather than using an existing Roth IRA account. There are circumstances where you may want to “recharacterize” the conversion back to a traditional IRA.
Whether to convert a traditional IRA to a Roth IRA is not a simple easy decision. A number of factors need to be considered. Please if you have any additional questions.
