New rules
for Roth IRA conversions in 2010
Till now,
Roth IRA conversions have played a relatively small role in the financial
plans of our clients. Only
taxpayers with adjusted gross incomes below $100,000 were eligible for
Roth conversion. We were only able
to convert some clients who had highly variable incomes (e.g. authors,
performers) or who had ducked into graduate school for a couple of years,
or whose income fell temporarily for one reason or another.
The major
rule change for 2010 is that the conversion income limit goes away. Investors of every income level are now
able to convert not only a regular IRA, but also other retirement plans including
SEP and SIMPLE plans. Also, some
clients may have the option of converting their workplace 401k or 403b
plans to ROTH 401k and 403b's. The
IRS still phases out ROTH contributions for single taxpayers with AGI
starting at $105K, or joint filers with AGI greater than $166K. However, taxpayers at that income level
can make the same dollar contribution to a conventional IRA and
immediately convert (which makes no economic sense, but reflects the
haphazard way tax laws are implemented.)
Effective January
1, 2010
· Elimination
of $100,000 adjusted gross income limitation for conversion eligibility
· Clients
with other types of IRAs can "convert" assets to a Roth with no
early withdrawal penalties
· Clients
that convert must pay taxes on converted assets at current income rates,
which could be lower than future rates if tax rates rise, or higher now
if a client's retirement tax bracket is much lower.
· Those
converting in 2010 can elect to spread tax liability over two years (i.e.
half the tax would be owed April 15, 2011, the other half April 15,
2012.)
· Qualified
distributions are tax free!-including any growth
· No
minimum required distributions from age 70 ½ -all assets have the
opportunity to grow and compound even during retirement
· Distributions
of inherited Roth IRA's to beneficiaries are estate tax (and penalty)
free and future distributions from the inherited IRA to the beneficiary
are tax-free.!
· Conversions
can be "recharacterized" or reversed up to October 15th of the
year following the conversion (if for example the tax bill proved too
onerous or the value of the assets in the ROTH fell sharply after
conversion.)
· Partial
conversions are allowed (e.g. convert half an IRA now, the rest at a
future date.)
· The
conversion tax is applied only to "pre-tax" contributions. If a client had funded an IRA or 401K
with after-contributions, those funds (but not the growth) are excluded
from the conversion tax.
Generally, retirement plans include records of which contributions
were after-tax - be careful not to overlook that information.
Generally,
clients with one or more of these characteristics should consider a Roth
conversion
· Have
at least 5 years remaining until retirement, which will give the
converted assets enough years of tax-free growth to offset the value of
taxes paid on conversion.
· Have
liquid assets available to pay the conversion tax outside of assets in
the IRA. Using the assets of the
IRA to pay the tax negates any advantages by creating "early
withdrawal" penalty taxes and reducing a client's "tax
deferred" asset base.
· Expect
current income tax rates to rise (our best guess is that the top federal
bracket rises from the current 35% to 42% in the next couple of years.)
· Expect
to be in a low income bracket this year (bearing in mind that the amount
of the converted assets is added to AGI, which might push the client back
into the higher bracket.)
· Does
not expect to draw down retirement assets (taxable assets are more than
sufficient for retirement lifestyle) and would rather shift those assets
to heirs.
Roth
Conversion Evaluation
If you
think you meet these characteristics and are interested in learning more,
set up an appointment with us for a complimentary Roth Conversion
Evaluation. We will enter
basic information about your age, spouse's age if applicable, income
levels and deductions, federal and state tax brackets, and make some
projections about future investment returns. From that information, we will be able
to project how much converting all or part of your IRA assets today will
cost, and how much benefit you will gain in the future.
Yours sincerely,
David Edwards
President
Heron Financial Group, LLC, is an SEC registered investment advisor
providing fully managed investment and wealth management services to
individuals, families, trusts, defined benefit plans and
corporations.
