Considering
 
 Conversion of your
 
 
IRA to a Roth IRA

If you have a Traditional IRA, you are enjoying income tax deferral on your contributions to the account and on the appreciation, if any, of your investments.  Later on, when you begin taking distributions out of the IRA, you will pay income tax.  Presumably, this will be at a time when your overall income is lower and so your taxes will be less.  That is, unless tax rates go up.  

In 1997, Congress introduced the Roth IRA, which allowed taxpayers with income less than $116,000, to make contributions of after-tax dollars, and, upon retirement, to take distributions income tax-free.  In addition, taxpayers who met the income limitation could convert their Traditional IRAs to Roth IRAs by paying income tax on the current value of the account. 

As of January 2010, the income limitation for conversion of a Traditional IRA to a Roth IRA has been removed, opening the door for those with large Traditional IRAs to fund Roth IRAs. 

Why incur income tax now?  It may be beneficial in the long run for either you or, ultimately, your family to pay the income tax now and allow the assets to grow income tax-free.  Whether conversion is beneficial or not depends on several factors such as:
  • Your current tax rate and your estimated future tax rate
  • Any favorable tax characteristics, such as a charitable contribution carryover
  • Your estimated federal estate tax liability
  • Your current and future cashflow needs
  • Your life expectancy and current health
  • The anticipated return on the IRA assets and your non-IRA assets
And the most important and least predictable factor of all, what Congress will do with income, estate and gift tax legislation in the near future. 
 
Generally, it is beneficial to convert if:
  1. Future income tax rates increase
  2. You can use non-IRA assets to pay the income tax incurred on conversion
  3. You don't need to withdraw any assets from the Roth IRA during your lifetime
  4. The assets in the Roth IRA appreciate over time
  5. You will be subject to estate tax, and
  6. You plan to leave the Roth IRA to young family members.
The income incurred upon conversion in 2010 is automatically deferred equally over 2011 and 2012 at the tax rates in effect for those years, or, by making an election to opt out, you can pay the tax in 2010, based on 2010 tax rates. 
 

Finally, you need not convert your entire Traditional IRA.  You may convert any part in 2010 and another part in 2011, etc.   And if, before you file your income tax return, you decide conversion is not beneficial, you can undo the conversion and re-characterize your IRA as a Traditional IRA. 
Thank you for reading this issue of the Cox & Nici E-News.  

Please visit our website or call us for more information regarding this subject or to answer any other questions you may have.

Sincerely, 





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