Is a Roth IRA Conversion for You?

When people ask for suggestions on financial planning opportunities, I tell them two words. Roth IRA.

How great would it be if you didn't have to pay taxes when you take distributions from your retirement account when you retire?

Maybe you could retire earlier! Or you may be able to save less for retirement! Maybe you could take 2 huge vacations in retirement rather than 1!

So what are the advantages of a Roth IRA?

• The earnings you make in a Roth IRA are not taxed, and the distributions you take from a Roth are not taxed. Keep in mind that when you contribute to a Roth, you do not get a tax deduction.

• There are no required minimum distributions from a Roth.

• When you've withdrawn all your contributions (regular and conversion), any subsequent withdrawals come from earnings. Withdrawals of earnings are tax-free if you're over age 59 • and at least five years have expired since you established your Roth IRA. Otherwise (with limited exceptions) they're taxable and potentially subject to an early withdrawal penalty.

• Based on your financial situation, it may make sense for you to convert an existing IRA into a Roth IRA. Upon conversion, you owed taxes on the dollar amount of the conversion - it's taxable at ordinary income. Depending on your circumstances, you may be able to avoid penalties without making any estimated tax payments on the taxable amount of the conversion. But once the money is in the Roth, it is not taxed again.

Why would you want to convert your IRA to a ROTH IRA?

• You expect to be in a the same or higher tax bracket when you retire.

• You think tax rates will be higher when you retire.

• You would like your heirs to inherit the Roth (tax free) status, and have a retirement account for them, where the distributions won't be taxed. They will be forced to take money out of the inherited Roth IRA based on their life expectancy. The balance of the Roth can continue to grow tax free.

• Estate planning strategies. When you convert your IRA, the money you spend to pay the taxes reduces your gross estate.

On May 17, 2006, President Bush signed the Tax Increase Prevention and Reconciliation Act of 2005 into law. This tax bill included a provision dealing with conversions of traditional IRAs to Roth IRAs. Conversions that occurred in 2010 will be able to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012.
This article is for informational purposes only and should not be construed as individualized investment advice.