Business - Is it time to switch over to a Roth IRA?

With the new year came changes in the tax code that allowed more people to convert their traditional independent retirement accounts (IRA) and 401(k) savings plans into Roth IRAs.

Since it was established by the tax code in 1997, many people saving for retirement have been reaping the benefits afforded by the Roth IRA as opposed to a standard Independent Retirement Account (IRA).

Named for the U.S. senator who passed the legislation, there are several well-known advantages to the Roth IRA:

* Direct contributions may be withdrawn at any time tax free.

* Earnings can be withdrawn tax free after 5 years and age 59-1/2.

* First time home buyers may withdraw up to $10,000 of earnings tax free.

* Distributions to your heirs are tax free after your death.

* No required minimum distributions after age 70-1/2.

Meanwhile, traditional savings vehicles such as IRAs and 401(k) plans offer the benefit of pretax contributions, but all distributions are subject to full taxation at ordinary rates (plus a 10 percent penalty before age 59?). Furthermore, after age 70?, taxpayers must start taking distributions from traditional IRAs, known as Required Minimum Distributions (RMDs).

The changes that went into effect Jan. 1 allow anyone to convert all or a portion of their traditional IRA into a Roth IRA.

Prior to 2010, conversions from standard IRAs to Roth IRAs were only available to those with less than $100,000 of adjusted gross income. The removal of the income limitation is permanent, but there is an added incentive to do a conversion this year: For 2010 only, the income taxes due as a result of the conversion can be spread out over two years and paid in 2011 and 2012.

There are several factors to consider in your decision of whether or not to convert to a Roth IRA:

-- Your age.

-- Planned retirement age.

-- 2010 tax bracket.

-- Anticipated future tax bracket.

-- Balance of investments both inside and outside of IRAs.

-- Most importantly, your desire and ability to pay the out-of-pocket tax due on the conversion.

If you expect your savings to accumulate for a long period of time, expect to be in a higher tax bracket in the future, or do not anticipate needing the money at all during your lifetime, then a conversion may lead to significant income tax savings over the course of your lifetime, and potentially estate tax savings as well.

However, the most significant drawback to converting is that the taxes due on the amount of the conversion must be paid now, as opposed to years from now when distributions from the IRA would have otherwise been made.

There is also considerable concern that investors will be voluntarily accelerating these taxes in exchange for the promise of tax-free distributions later, but that subsequent tax law changes may erode those benefits, particularly for higher-income taxpayers.

As with so many planning concepts, there is no clear cut answer as to whether this opportunity will be a benefit or a cost in the long run. Your individual circumstances must be reviewed with your financial and tax advisors to determine if a conversion is right for you.


David Berman is a Principal with Berman McAleer Inc. in Timonium. Securities and investment advisory services offered through NFP Securities Inc. NFP Securities does not provide tax or legal advice.

Published: Tue, Feb 23, 2010


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