Posts Tagged ‘Conversion’
Roth IRA Conversion: Does It Make Sense For You?
What is a Roth IRA Conversion and does it make sense for me. You may actually have a great opportunity to benefit yourself and your family by means of a Roth IRA Conversion but only if your situation is right. First of all a Roth IRA Conversion is converting money from your traditional IRA (assuming you have one) to a Roth IRA.
How could this benefit you? Consider the differences between the two types of IRAs. A traditional IRA allows you to make a contribution with money that is not taxed giving you a tax break for the year you contribute. (Contributions to traditional IRAs are a subject for another blog entry.) Traditional IRAs grow without incurring taxes but then the deductible contributions and profits are all taxable when they are taken out of the account. If they are taken out before you turn 59 1/2 the withdrawals may be subject to a 10% penalty with some exceptions. Also, there are required minimum distributions out of traditional IRAs starting the year you turn 70 1/2 years of age.
Roth IRA contributions are taxed meaning you do not get a deduction on your tax return for this contribution. However, Roth IRAs grow tax free and are not subject to tax when you withdrawal the money provided you are at least 59 1/2 years old and have had the account for at least five years. That is correct, the profits on the contributions are not taxable provided you meet the above requirements. In addition, there are currently no required minimum withdrawals from a Roth IRA at any age.
A Roth IRA conversion is taking money from a traditional IRA and converting it to a Roth IRA. This conversion can be and usually is a taxable event. You will be subject to income tax on the pretax contributions and the earnings withdrawn from a traditional IRA to convert to a Roth IRA. When you convert money from a traditional IRA to a Roth you are not subject to a early withdrawal penalty even if you are not yet 59 1/2 years old.
How can this benefit you? First, if because of your tax situation for 2010 you are able to avoid paying income tax on the conversion amount then you have a free conversion of untaxed money that you will not pay income taxes on in future assuming you meet the requirements. Also you will not pay income taxes on the profits of these invested funds if you leave the money in the Roth IRA account until you attain to 59 1/2 years of age and have the account for at least five years. Second, if because of your tax situation for 2010 you have to pay income tax on the money converted it may make sense if you expect the taxes you will owe on the conversion will be less or equal to the taxes you would have paid in the future when you would have withdrawn the money from your traditional IRA. This is appealing to many because they have the expectation that their tax rate will increase or because the expected profits on the money to be converted will be significant. Finally, since there are no required minimum distributions at any age from a Roth IRA you could allow more money to grow tax free for you to leave to your heirs.
There would be no point to the Roth conversion if you do not expect you will need to pay taxes when you withdrawal the money from your traditional IRA in retirement. How could you avoid paying taxes on the withdrawals from your traditional IRA? If your taxable income including the withdrawals from your traditional IRA are less than your standard or itemized deductions and exemptions.
So you should consider the following factors before making a conversion to a Roth IRA from a traditional IRA:
How much tax will I incur on the conversion?
What will this do to my tax rate this year?
What other impact will it have this year on credits and itemized deductions and other factors based on income amounts?
When will you need the money?
How much profit do I expect to make on this account?
What affect will it have on future taxes?
What future taxes would I have paid from withdrawals out of the traditional IRA?
Am I planning to pass this money on to my heirs?
KEEP IN MIND WHEN YOU DO A ROTH CONVERSION YOU CAN CONVERT JUST A PORTION OF YOUR TRADITIONAL IRA. YOU DO NOT HAVE TO INCLUDE ALL OF YOUR TRADITIONAL IRAS IN A ROTH CONVERSION.
Tax/Financial Planning. In many cases it is helpful to have access to money in retirement that will be both taxable and not taxable to you. Traditional IRAs withdrawals will generally be taxable to you. Roth IRA withdrawals after 59 1/2 years of age and after you have had the account five years will not be taxable to you. Also, money and investments that you paid tax on when you earned it will not be taxable to you at that time but only any untaxed profits may be subject to tax.
How much income tax will I be subject to if I withdrawal money from a Roth IRA before I have had the account for five years? Only the profits from Roth IRAs are subject to tax on early withdrawals. The principal amount has already been taxed and therefore will not be subject to tax when withdrawn.
Conversion Limits. In prior years there were income limitations regarding allowable Roth conversions and in 2010 there is no income limitation. This is why there has been so much discussion about these conversions for 2010. No one knows what the future will bring regarding any limitations.
A word of caution: be careful about using money from your traditional IRA to pay any taxes on a Roth conversion. Money withdrawn from your traditional IRA to pay this tax may be subject to both tax and the 10% early withdrawal penalty.
Other Points. Also, if your employer has a plan check with the plan administrator to see if a Roth conversion is allowed.
Also, for 2010 you have the option to split the income from a Roth conversion to apply your 2011 and 2012 returns. So there may be a potential benefit for you there if your tax rate does not rise.
I would be happy to review your scenario with you and answer any questions that you may have. Remember I look at the income tax consequences for you so it will be a good idea for you to review your situation also with your financial planner. If you have any questions about Roth conversions or would like a free consultation call me or email me at:
Jeff Haywood, CPA
972-439-1955
jeff.jhtaxes@gmail.com
twitter.com/jeffhaywoodcpa
These posts provide highlights that may be of interest to taxpayers. For complete information on these subjects check with the IRS and your financial consultants.
I prepare the following types of tax returns:
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Also, I am available for tax planning and discussions about business, retirement planning and life goals.
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As always keep in mind that the content provide on this site is general in nature and may or may not apply to your particular case. It is best to check with a tax professional about your circumstances and what is best for you personally. Also, IRS regulations and tax laws are constantly changing and the information on this site is not constantly updated. Again please check with me about your particular circumstances and what will be best in your situation at the given time and law.
This article was written by Jeff Haywood, CPA.
Jeff is a licensed CPA in both Texas and Illinois.
He has prepared income tax returns for the public for over 10 years.
He also has an MBA in Finance from Loyola University in Chicago and he has 24 years experience in Corporate Finance and Business Analysis.
