Coming soon: More of a good thing
There’s a savings vehicle in which all earnings, appreciation, and interest can be free of income tax forever. If the rules are met, there’s no RMD to be taken, no income tax due on withdrawals, and, while the account assets are included in your estate, withdrawals by your beneficiaries can also be tax-free. It hasn’t been available to everyone because of income limits, but it soon will be.
I’m speaking about the Roth IRA, of course. Until now, higher-income taxpayers ($100,000 modified adjusted gross income or higher) couldn’t convert their savings from a traditional IRA to a Roth. But that’s about to change.
While the rules around contributing to a Roth IRA aren’t affected*, beginning January 1, 2010, traditional IRAs held by taxpayers exceeding the income limits can be converted to Roths. Some of you have even planned ahead by making contributions to nondeductible traditional IRAs with plans to convert in 2010. As an added bonus, only for those conversions completed in 2010, the taxable income triggered by the conversion can be spread equally over two tax years.
I believe the Roth IRA is one of the best tools in a taxpayer’s arsenal for saving, accumulating assets, and then spending in retirement (or leaving to family). It’s right up there with the 401(k). An invention of the Taxpayer Relief Act of 1997, the Roth coincided in close proximity with reductions in income tax rates. Since contributions are after-tax, this made the Roth even more attractive.
This rule change will be an opportunity for increased tax diversification if your before- and after-tax holdings have been out of balance. This may be significant if you feel that income tax rates are likely to rise in the future. Converting traditional IRA assets to a Roth IRA in 2010 or later locks in the “tax cost” at then-current rates.
If you specifically want to use a Roth IRA to pass assets on to another generation in a tax-sheltered vehicle, conversion might be a good choice for you. Also, it may be the right move for a young job-changer with a rollover IRA and a low marginal tax bracket.
It may be more of a good thing. It may be too late for some. It may be a perfect opportunity for you. The decision is not without complications.
With the recent market downturn, it would certainly be less expensive, tax-wise, to convert now than it would have been before the recession. But is it worth it? After all, you’ll need cash from some other source to pay the taxes due. And if you’re nearing retirement and expect your income to be lower in retirement, you may want to walk away from a conversion.
You’ll be hearing a lot on this topic in coming months from Vanguard and other sources. Before making a decision, take some time, consider all the variables, talk to a professional tax advisor if you need to, and then determine if a Roth conversion makes sense for you.
* The maximum modified adjusted gross income limits to contribute to a Roth for 2009: $120,000 for individuals, or $176,000 for couples filing jointly. These limits will continue to apply in 2010, although the limit for joint filers will be raised to $177,000 in 2010 as a result of a cost-of-living adjustment.
Convert IF you trust Barney Frank, Chris Dodd et. al. not to alter the rules. Barron’s published a piece ~ 15 to 18 months ago describing how Capitol Hill could change the rules of the Roth game while (tongue in cheek) denying doing so - e.g., require that as of some date your remaining balance would be taxable; or, requiring that one take out a given percentage each year in order for the balance to remain non-taxable; or, passing a tax on your Roth account’s earnings /income while leaving the basis or corpus non-taxable.
The article is worth reading. Give the present record budget deficit, the “tax and spend” crowd must be drooling over the potential short-term “windfall’ if lots of folks convert in 2010. Perhaps the best solution is to PARTIALLY convert - half? / one-third? two-thirds? whatever. Wish my crystal ball were less fallible.
Do you really trust the U.S. Govt. not to change the rules regarding Roth’s? Isn’t it probable that: “Of course your Roth withdrawals are not taxable, but you must include them in income to get the tax rate on your other income. After all, it is only fair…”
This is an appealing alternative but then everyone’s situation is different. I am nearing retirement, is there a calculator that can give us more information about the conversion?
Investors may need advice on how to estimate the amount that may be converted to a Roth without pushing into a higher tax bracket. This is a tricky calculation, probably best done near the deadline for a 2010 conversion. What is the deadline for a 2010 conversion? Dec. 31, 2010? April 15, 2011?
How is your analysis impacted if congress passes a national sales tax or VAT? A Roth IRA owner could end up paying tax twice on account assets, once when contributed and again when assets are removed from the account and used to purchase goods and services. As a nation, I don’t think we have every been closer to the possibility of a national sales tax.
Thanks
I have a after-tax contribution in my 401(k). How can I roll it over to Vanguard’s Roth IRA account?
Insuring Congress lives with term limits (12 years max) and no special treatment………. Government mandated Social security benefits/Medicare will insure people such as Dodd and Frank make changes that will not impact them since they will be forced to live with their decisions. We need a contract with the taxpayers to accept term limits now!
You wrote a fine rundown of the Roth conversion but you
relate to 2010! We are not there yet! How about 2009 that
is my concern now. I have tax credits I must apply to
this year or lose same, you were of NO help —PEZ
I will turn 70 in May 2010. My question, assuming no limit in current income to convert all my Conventional IRA’s to Roth IRA’s in 2010 and beyond, and the added goody of splitting tax due into a 2010 and 2011 piece, will my IRA’s qualify (my understanding of the RMD is your first required distribution is due in the year you turn 701/2, for me 2010)? Will my age nullify this opportunity? Can anyone recommend a good calculator to help me calculate the trade-offs, Roth versus stay with my Tranditional IRA’s in 2010?
Thanks, Judy
I have after tax contributions in my Traditional IRA.
How does this affect the Traditional IRA to Roth IRA transfer and the taxes one has to pay?
For example, if I contributed $50,000 on an after tax basis to my Traditional IRA (between 1990 and 1995), and I now want to transfer this to the Roth IRA, how do I do this and what are the tax consequences. (Assume today’s value of this $50,000 is now $65,000).
Any advice is very much appreciated.
Is it necessary to remove the 2010 RMD before converting the IRA balance to a Roth?
Retired 30 years. Ages 72 abd 75. Exellent health. Need tax free bonds muni were recommended. With fast talking brokers we have been burnt in the past and need simple investment w/o big fees. Any ideas?
What is Vanguard’s fee for maintaing a roth account. I have a roth account that I would like to switch to vanguard. It only has 400.00 in it. Is that possible
Quote from you IRA Conversion Article: “…assets are included in your estate…” That means that if you and your spouse have over $2 million in all assets including property, you will be paying tax on the Roth IRA at what ever the death tax is at death of the second spouse. You could divide the Roth IRA into several different accounts titled to children or others so that your surving spouse does not go over $2 million in assetts. Then again you need some liquid assets to pay Federal and State Estate settlement.
The problem is the government keeps changing the rules. The rules were made to get people to save for retirement, but if the government did not penalize people for working and saving, there would not be a need for an incentive to get people to save. Think of all the administrate time wasted on trying to out guess what he government wants to get a tax break. Think of all the money wasted lobbying Government to get special tax breaks. We need a simple FLAT TAX at a low rate. We need less government administration and more freedom to do what we know is best with our earnings.