Consider Converting to a Roth IRA

There are many great websites offering Roth conversion calculators.

Roth IRAs are typically limited to taxpayers earning less than federally-established thresholds.  Conversions from traditional or rollover IRAs to Roth IRAs were also limited by modified adjusted gross income.  But this year, Roth conversions are permissible for all taxpayers regardless of income level.

What that really means is that the IRS is going to collect taxes on the amount converted as if you withdrew the money.  But instead of withdrawing it, you are actually putting it into a Roth IRA account that will grow without taxes forever and also without the withdrawal rules that traditional IRAs impose on you. 

You may either pay 100 percent of the tax on the converted amount in 2010 or split the amount and pay half in 2011 and the other half in 2012.  The best decision on this is to take your best guess about when you’ll be in the lowest tax bracket.  And while no one knows for sure, there is sentiment in Congress about increasing revenues through higher taxes in the near term.  

The downsides of a Roth conversion include paying taxes now versus when you eventually withdraw the money, penalties and taxes on amounts withdrawn before 50½ and the income limits for qualification.

You may wonder if this is worth your time and tax dollars now.  There are no right or wrong answers because of the variables yet to unfold in your life.  Some significant variables include the rate of return of your invested account, tax rates at the time of conversion and the time of withdrawal for traditional IRAs not converted. 

There are many great websites offering Roth conversion calculators.  Use more than one to see if the numbers part of the analysis is similar.

Another benefit of this year’s special rules includes what I call a do-over provision.  This is your ability to unwind the Roth conversion by the time you file this year’s tax return.  In prior years, some people who made Roth conversions have been burned by paying taxes on a large amount converted that precipitously lost money in volatile investments.

If your investment loses substantial value between the date of conversion and the filing of your 2010 tax return, you can roll those funds back to a traditional IRA and not pay taxes on the amount converted.  Your investment is still worth a lot less, but at least you didn’t get burdened from the taxes on a significantly higher amount.

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John P. Napolitano
U.S. Wealth Management
uswealthcompanies.com
Phone: (781) 849-9200
 
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