IWS Investor Newsletter Issue No. II • Summer 2010
Eric Wikstrom's
Retirement & Wealth Planning Advisor
Roth IRA conversions -
If you've looked at the financial press recently, you may have noticed an article or two about Roth IRA conversions and something about the year 2010. What's the significance?
Well, up until 2010, high-income individuals were generally not allowed to contribute to a Roth IRA nor convert their traditional IRA funds into a Roth IRA. That is because Congress set income ceiling limitations on how much an individual could make to both contribute and convert to a Roth IRA.
Noting that the Federal Estate Tax in 2010 is actually going to be 0%, yes, that's right, 0%, Congress decided that to partially make up for this revenue shortfall, they would allow individuals with any amount of income to be able to convert "traditional" retirement accounts to Roth retirement accounts. So the $100,000 Modified Adjusted Gross Income limitation for Roth IRA conversions is being eliminated started in year 2010.
Now, before you get too excited, just because you can do something doesn't mean you should. But in this case, you should probably consider converting some traditional retirement account funds into Roth retirement funds, if for no reason other than to get the 5-year Roth clock started.
How does this process work? Well, for every dollar of traditional retirement account (traditional IRA, SEP-IRA, 401(k) plans, 403(b) annuity plans, 457 plans, etc.,) that you "convert" into a Roth IRA, you will include that amount as taxable income on your Form 1040 based on the value of the conversion on the date that you convert. Keep in mind that you will pay tax on these "converted" retirement funds at ordinary income rates in the year of conversion. So it's important to know and understand a little about what "marginal" income tax bracket you're in to make an accurate determination of the taxes you'll owe on the conversion.
But before you get too depressed over paying taxes today on retirement funds you may not need for many years, here are a few key points to consider:
1) All Roth IRA funds are tax-free when withdrawn -
Not tax-deferred like traditional retirement accounts, but tax free (as long as you meet the 5 year rule and are over the age of 59 1/2). So accumulating some amount of tax-free retirement funds in addition to tax-deferred funds can provide you more cash-flow options when need your retirement dollars. This is because no one knows where tax rates will be in the future, nor what tax rate they'll be in.
2) Taxes on the Roth conversion can be paid over 2 years -
Usually when you convert traditional retirement funds to a Roth IRA, you would include the amount of conversion in your taxable income in the year conversion. So converting some traditional IRA funds to a Roth in 2009 would result in you paying tax on this conversion by 4/15/2010. But Congress is giving everyone a fantastic gift in that if you convert in 2010, you'll be able to pay the tax on your 2011 and 2012 tax returns! This is not a typo!
So you would pay 50% of the taxes due from the 2010 conversion on your 2011 Form 1040 (these taxes would be due 4/15/2012) and 50% of the taxes would be included on your 2012 Form 1040 (taxes would be due 4/15/2013). Talk about utilization of the time value of money concept!!! This is your one chance to take advantage of paying your taxes way off in the future as opposed to the year after conversion.
3) You can "recharacterize" your 2010 Roth conversion by 10/15/2011 -
This is another great gift provided by Congress and equates to an adult "do over." So if you converted an IRA investment with a fair market value of $500,000 on January 2, 2010, and by 10/15/2011 (21 months later!!!) that same investment had dropped in value to $400,000, you wouldn't be feeling too good about paying taxes on $500,000 when the value of your investment was $100,000 less. So this is where the recharacterization comes in.
You can decide up until 10/15/2011 to unwind your conversion decision. Not a bad deal. So you really can't go wrong here by converting some IRA funds to a Roth because you can always change your mind later. But even though you can change your mind, you'll want to give some careful consideration on what asset types are actually in the IRA account you convert because of a rule which prohibits "cherry-picking" of just the investments that decrease in value.
Well, those were just a few of the fantastic benefits of what tax year 2010 has in store for you and your retirement planning. I utilize some great software analysis tools that can help you understand what a Roth conversion can mean to you. Please feel free to call or email if you would like to discuss an in-depth Roth conversion analysis.
Back to 2010 Summer Newsletter main page
Well, up until 2010, high-income individuals were generally not allowed to contribute to a Roth IRA nor convert their traditional IRA funds into a Roth IRA. That is because Congress set income ceiling limitations on how much an individual could make to both contribute and convert to a Roth IRA.
Noting that the Federal Estate Tax in 2010 is actually going to be 0%, yes, that's right, 0%, Congress decided that to partially make up for this revenue shortfall, they would allow individuals with any amount of income to be able to convert "traditional" retirement accounts to Roth retirement accounts. So the $100,000 Modified Adjusted Gross Income limitation for Roth IRA conversions is being eliminated started in year 2010.
Now, before you get too excited, just because you can do something doesn't mean you should. But in this case, you should probably consider converting some traditional retirement account funds into Roth retirement funds, if for no reason other than to get the 5-year Roth clock started.
How does this process work? Well, for every dollar of traditional retirement account (traditional IRA, SEP-IRA, 401(k) plans, 403(b) annuity plans, 457 plans, etc.,) that you "convert" into a Roth IRA, you will include that amount as taxable income on your Form 1040 based on the value of the conversion on the date that you convert. Keep in mind that you will pay tax on these "converted" retirement funds at ordinary income rates in the year of conversion. So it's important to know and understand a little about what "marginal" income tax bracket you're in to make an accurate determination of the taxes you'll owe on the conversion.
But before you get too depressed over paying taxes today on retirement funds you may not need for many years, here are a few key points to consider:
1) All Roth IRA funds are tax-free when withdrawn -
Not tax-deferred like traditional retirement accounts, but tax free (as long as you meet the 5 year rule and are over the age of 59 1/2). So accumulating some amount of tax-free retirement funds in addition to tax-deferred funds can provide you more cash-flow options when need your retirement dollars. This is because no one knows where tax rates will be in the future, nor what tax rate they'll be in.
2) Taxes on the Roth conversion can be paid over 2 years -
Usually when you convert traditional retirement funds to a Roth IRA, you would include the amount of conversion in your taxable income in the year conversion. So converting some traditional IRA funds to a Roth in 2009 would result in you paying tax on this conversion by 4/15/2010. But Congress is giving everyone a fantastic gift in that if you convert in 2010, you'll be able to pay the tax on your 2011 and 2012 tax returns! This is not a typo!
So you would pay 50% of the taxes due from the 2010 conversion on your 2011 Form 1040 (these taxes would be due 4/15/2012) and 50% of the taxes would be included on your 2012 Form 1040 (taxes would be due 4/15/2013). Talk about utilization of the time value of money concept!!! This is your one chance to take advantage of paying your taxes way off in the future as opposed to the year after conversion.
3) You can "recharacterize" your 2010 Roth conversion by 10/15/2011 -
This is another great gift provided by Congress and equates to an adult "do over." So if you converted an IRA investment with a fair market value of $500,000 on January 2, 2010, and by 10/15/2011 (21 months later!!!) that same investment had dropped in value to $400,000, you wouldn't be feeling too good about paying taxes on $500,000 when the value of your investment was $100,000 less. So this is where the recharacterization comes in.
You can decide up until 10/15/2011 to unwind your conversion decision. Not a bad deal. So you really can't go wrong here by converting some IRA funds to a Roth because you can always change your mind later. But even though you can change your mind, you'll want to give some careful consideration on what asset types are actually in the IRA account you convert because of a rule which prohibits "cherry-picking" of just the investments that decrease in value.
Well, those were just a few of the fantastic benefits of what tax year 2010 has in store for you and your retirement planning. I utilize some great software analysis tools that can help you understand what a Roth conversion can mean to you. Please feel free to call or email if you would like to discuss an in-depth Roth conversion analysis.
Back to 2010 Summer Newsletter main page
Why 2010 is an important year for your IRA planning