New tax law lets rich convert to Roth IRA, too
By Sandra Block
By Sandra Block
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.