Sponsored by:

Comment, blog & share photos

Log in | Become a member
The Honolulu Advertiser
Posted on: Thursday, May 18, 2006

New tax law lets rich convert to Roth IRA, too

By Sandra Block
USA Today


While Roths offer many advantages, converting won't necessarily save you money. Factors to consider before you convert:

  • Your expected tax bracket in retirement. If you think your tax bracket will fall significantly, you may be better off leaving your IRA alone and paying the taxes on the money once you take it out.

    T. Rowe Price offers an IRA calculator at its Web site, www.troweprice.com.

  • How long before you take withdrawals from the converted IRA. In general, the longer you have until you plan to withdraw your earnings tax-free, the better, because the earnings will have more time to grow.

  • How you'll pay the tax bill. A conversion makes sense only if you have money outside your IRAs to pay the tax bill, financial planners say. If you do take money out of your IRAs, you'll owe income taxes and a 10 percent penalty if you're younger than 59 1/2.

  • There's one other important factor to consider: politics. Between now and 2010, lawmakers might decide that allowing high-income taxpayers to shelter millions of dollars from taxes isn't fiscally prudent. The provision is expected to raise $6.4 billion over the short term, as savers pay taxes to convert their regular IRAs to Roths. But the Tax Policy Center, a non-partisan think tank, estimates that over the long run, the provision will reduce tax revenue by $16 billion.

  • spacer spacer

    Preparing for something that won't happen until 2010 is hard, especially if you're still trying to figure out what you're going to have for dinner tonight. But if your income has disqualified you from investing in a Roth individual retirement account, you might want to start planning ahead.

    The $70 billion tax-cut bill President Bush signed into law yesterday will let upper-income taxpayers convert their traditional IRAs into Roths, starting in 2010. Contributions to a Roth IRA aren't tax-deductible. But as long as you own the account for at least five years and wait until you're at least 59 1/2 to take withdrawals, gains on your investment are never taxed.

    When Congress created Roth IRAs in 1997, it also let people convert their traditional IRAs to Roths, as long as they first paid taxes on their pretax contributions and investment gains. But the law limited those conversions to taxpayers with adjusted gross incomes of $100,000 or less, whether married or single.

    In the measure approved last week, Congress also included a provision that will ease the tax hit on IRA conversions. If you convert your IRA to a Roth in 2010, you won't have to pay any taxes on the conversion that year. You'll be allowed to pay half your tax bill in 2011, the other half in 2012.

    Financial planners say the biggest beneficiaries of the change will be high-income workers who had rolled a former employer's 401(k) into a traditional IRA and wish to convert some or all of that money into a Roth. "A lot of our clients are interested in doing this," says William Supper, a financial planner at Massey Quick in Morristown, N.J.

    Unlike traditional IRAs, Roths aren't encumbered by minimum distribution requirements. So you won't be required to start taking money out when you turn 70 1/2.

    This feature makes Roths a good estate-planning tool, Supper says. If you don't need the money in your Roth to pay your retirement expenses, you can leave it all to your heirs. Unless your estate is large enough to trigger federal estate taxes, your heirs will inherit your Roth tax-free.

    Congress didn't change the income eligibility requirements for contributing to a new Roth IRA. Singles with AGI of more than $110,000 can't invest in a Roth; for married couples, the cutoff is $160,000. But lifting the conversion cap would provide a way for high-income workers to bypass those limits. They could invest in a nondeductible IRA, then convert it to a Roth.

    Some financial advisers are suggesting their clients start contributing to a nondeductible IRA now so they'll have more to convert in 2010. Nondeductible IRAs are the only IRAs available for taxpayers who don't qualify for a Roth or a deductible IRA.

    Ed Slott, an accountant and IRA expert in Rockville Centre, N.Y., says he doesn't usually recommend nondeductible IRAs because they're complicated to manage. When money is withdrawn from a nondeductible IRA, earnings are taxed at your ordinary income rate. They're also subject to minimum distribution rules.

    But "if you intend to convert the whole thing, you get rid of the paperwork," Slott says.