When the year 2010 began it opened up a whole new set of rules for the availability of Roth IRA’s to more taxpayers. Beginning January 1, 2010 all persons who own a traditional IRA, not just those who have modified adjusted gross incomes under $100,000, will be able to convert their traditional IRA accounts to a Roth IRA. That’s good news, but there are a number of considerations that you need to make in order to be sure that you are making the right decision. Don’t just assume it’s the correct thing to do.
Let me refresh your memory first as to the difference between a traditional and a Roth IRA. The former is done with pre tax dollars meaning that when you do begin to withdraw in the future the distributions will reflect taxable dollars. The Roth IRA is funded with after tax dollars and distributions are tax free. Additionally, traditional IRA’s require taking a minimum required distribution after age 70 ½. The original owner of a Roth IRA is not required to take a minimum distribution.
Now let’s complete the current ground rules. The income tax due on any conversions in 2010 can be spread over two years with half paid in 2011 and half in 2012. This sounds pretty good, I admit, but now the real fun begins as we look at the mistakes that you could make in reacting too fast!
Make sure that you understand the tax consequences, of which there are many. The first of which is to consider the implications of your marginal tax bracket. Let’s assume that a person is in a very low bracket of 15% and they have an IRA worth $500,000. Don’t think that by converting the IRA, it will also be taxed at 15%. The fact is that at that amount the tax calculation will step up through the marginal tax bracket range with some of the taxable income being subject to a rate as high as 35%.
You also need to look forward and consider if your tax bracket may be falling within the next few years. If you are currently in a high marginal tax bracket and planning on retiring shortly with the expectation that your income will drop considerably, that might suggest holding off benefiting from a lower tax rate.
Ok, I think that’s enough to “mentally digest” for now. But there is more that you need to know, so you will need to come back for Part 2 that will be following!
