The Potential Benefits of Converting to a Roth IRA
As of January 1, 2010 (and thereafter), the Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA) allows individuals to qualify for a Roth IRA conversion regardless of their
income level. In previous years, taxpayers with a modified adjusted gross income (MAGI) of $100,000+ have not been permitted to make Roth IRA conversions.
What happens when you make a Roth IRA conversion?
When you make a Roth IRA conversion, you pay income taxes on the amount you choose to convert—either all or a portion of your traditional IRA or other eligible retirement account
(i.e. §401(k),
§403(b)). Converted amounts are taxable in the year the assets are distributed from your account, not in the year they are deposited into the Roth IRA. Once converted,
these assets have the opportunity to grow tax-free1, and can provide tax-free income in retirement or a tax-free legacy for your heirs.
Tax implications for converting in 2010
If you make a Roth IRA conversion in 2010, you have the option to pay all the taxes on the conversion in 2010,
or average the taxes owed on the conversion over the next two years, i.e., in 2011 and 2012. But keep in mind that current law provides for an increase in tax rates in 2011. Therefore,
if you were to choose to average your tax payments over 2011 and 2012, you may be taxed at a higher rate.
Converting §401(k) / §403(b) assets to a Roth IRA
§401(k) and §403(b) assets may only be converted after separation of service. However, if
in-service distributions from your §403(b) plan are permitted at age 59½, you could convert your §403(b) assets at that time.
Converting to a Roth IRA may provide future benefits:
- Hedge Against Future Tax Increases — Considering current personal income tax rates and with the nation facing
unprecedented financial challenges in the years ahead, a Roth IRA may provide valuable tax-hedging advantages. Given the current national debt and the looming fiscal challenges
related to Medicare and Social Security, it’s not difficult to envision the possibility of being in a higher tax bracket during retirement, even for individuals who are currently
in the upper income tax bracket (35% for 2010).
- Tax Diversification in Retirement1 — Another advantage of Roth accounts relates to the potential benefits
of creating a diversified pool of both tax-deferred and tax-free sources of savings from which to generate retirement income. When most or all of your retirement assets are held in
traditional tax-deferred accounts, you do not have the flexibility to control your taxable income without foregoing retirement income and spending flexibility.
If you have all of your assets in traditional tax-deferred savings and wish to keep your taxable income for the year under a specific amount in order to remain qualified for certain
federal or state benefits or tax deductions (or, to avoid getting bumped up into a higher tax bracket), you will generally have to curtail your distributions for the year. This could
impact your standard of living. On the other hand, if you have a tax-diversified mix of traditional tax-deferred savings and Roth IRA tax-free savings, you may have the flexibility to
control your taxable income for the year while taking additional tax-free withdrawals as needed from Roth IRA savings to maintain your desired level of income.
- Legacy Planning — If you are planning to leave a financial legacy, Roth IRA savings can provide tax advantages as
distributions are not required at age 70½—unlike traditional tax-deferred IRA, §403(b) and §401(k) assets. If you wish, you may leave Roth IRA assets untapped—and potentially growing
tax-free—throughout your lifetime. In addition, if you’re married, your spouse is eligible to roll the Roth IRA funds into his or her name following your death. This can provide for
further tax-free growth potential, until the assets are turned over to your heirs as a financial legacy.
You may wish to consider a conversion if:
- You have an outside or non-IRA source for the taxes needed to be paid on the conversion amount.
- Your tax bracket is lower than the IRA beneficiary's tax bracket.
- You have an investment time horizon of at least 10 years after the conversion.
- You have non-deductible contributions in your traditional IRA.
- You anticipate that your tax bracket will be the same or higher at retirement.
- You do not wish to be required to take minimum distributions at age 70½.
To find out if a Roth IRA conversion makes sense for you, please contact a Legend Advisor.
1Distributions from a Roth account are tax-free provided the account has been open for at least five years and the individual is over age 59½. Otherwise, withdrawals
of earnings may incur a 10% penalty.
Legend Equities Corporation and its affiliates do not provide tax or legal information or advice.
Carefully consider taxes, fees and other expenses before initiating an IRA conversion.