Roth Relief
New rules for 2010 mean new opportunities.

Of all the weapons in the retirement investing arsenal, few are as powerful as the Roth IRA. Unfortunately, not everyone who might benefit has been able to take advantage of this important investment vehicle.

Since its inception over a decade ago, Roth IRA investments have been subject to income limits. Currently, eligibility begins to phase out for single taxpayers with a modified adjusted gross income (MAGI) above $105,000. For married taxpayers filing jointly, eligibility starts to phase out with a MAGI above $166,000. So a married upper-middle class couple (say, a lawyer and elementary-school principal), would likely never have been able to open Roth IRA.

This is about to change. Beginning in 2010, the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) provides a way for higher-income taxpayers to enjoy the benefits of a Roth IRA. These new rules remove the MAGI limitations on rollovers from traditional IRAs into Roth IRAs. As a bonus, taxes on these rollovers can be paid in equal installments over 2011 and 2012.

For example, let’s say you have a traditional IRA currently valued at $100,000. You can convert this to a Roth in 2010. Most likely, you’ve funded this traditional IRA with pretax dollars (that is, you’ve never paid tax on it). Because of this, as you convert, the $100,000 registers as taxable income. Let’s also assume that, according to your tax profile, this results in $30,000 in income tax. With the new rules, you can pay $15,000 in 2011 and $15,000 in 2012— and $0 in 2010!

Clearly, these new rules are a home run for many investors. But will rolling over from a traditional IRA to Roth IRA be right for you? Ask yourself these questions:

• How long before I have to take a distribution? Cashing out your traditional IRA to reinvest in a Roth IRA will result in a taxable distribution. Make sure your time frame allows you to recoup the resulting taxes.
• Do I need the tax deduction that I currently make on my traditional IRA? Contributions to Roth IRAs are not tax deductible, so this could have a sizable effect on your bottom line.
• When I retire, will I be in a higher tax bracket or a lower tax bracket? The rollover is taxed based on your situation today. If you anticipate being taxed at a lower tax rate in your golden years, it may make more sense to let your money grow in a traditional IRA.
• Am I able to pay the taxes on my conversion from my income or non-retirement savings? Taking money out of your traditional IRA to pay for its conversion to a Roth will cut the amount that can grow tax free in the new Roth IRA. What’s more, if you are under the age of 59½, you are likely to pay a 10% penalty on the portion of the IRA used to pay the tax. So, if you don’t have the cash to cover conversion-related taxes, this may also be a sign to not convert.
• Will the distribution from my traditional IRA put me in a higher tax bracket this year? Moving into a higher tax bracket could leave you disqualified from valuable tax breaks such as dependent-child and college-tuition credits.
• Have I inherited the traditional IRA from someone other than my spouse? If so, you may also be disqualified from rolling your traditional IRA into a Roth IRA.

The new Roth rules are a golden opportunity for some, but clearly the situation is not without its complications and hazards. That’s why an experienced advisor is essential, both to assess whether a rollover is in your best interests, and to guide you through the process. Contact us today to begin planning!