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ROTH Conversions 2010

Finance

Issue: December 2009

By: Jerry Mosher, CFP

The government has decided that, in 2010, anyone with existing tax-deferred retirement assets will be allowed to convert them to a Roth IRA. Formerly, there were income restrictions on being able to execute this type of conversion. If your adjusted gross income exceeded $100,000 you were not eligible for a conversion. In addition to eliminating the restriction in 2010, people have the option of proportionally spreading the 2010 tax conversion liability through 2011 and 2012.

For those who may not be familiar with the distinctions of a Roth, a review might be helpful. There is a contributory Roth IRA which is distinct from a conversion Roth. If you are eligible for a contributory Roth, it means you can make a non-deductible contribution of $5,000 or $6,000, depending on your age, for any given tax year and your investment will grow tax free. The ultimate withdrawals will be tax free as well and this same status can be passed on to a beneficiary. This would be very beneficial for someone who is young and eligible to make a contribution.

A Roth conversion is when you convert all or a portion of existing tax-deferred retirement assets to a Roth IRA. In the year of conversion, the proceeds that are converted must be counted as taxable income and added to your other taxable income for the year. This means the converted proceeds will be subject to your highest marginal tax bracket. Obviously, if you are in a low tax bracket the conversion has more appeal from a tax standpoint than it does if you are in a high marginal tax bracket. The taxes that have to be paid do not have to come from the money that is converted and in fact it is preferable to pay them out of personal assets that have been accumulated so that more money is left in the Roth IRA to grow tax free.

To recap, some of the benefits of a Roth are: 1) there are no required minimum distributions (RMD), 2) growth is tax free, 3) there are tax and penalty-free qualified distributions for clients and their beneficiaries, and 4) there could be the satisfaction that if tax rates rise in the future, your Roth will not be subject to these increased rates.

Some of the potential drawbacks of a Roth conversion are: 1) you have to pay taxes on the amount of income that is converted thereby reducing your overall investment portfolio, 2) Roth conversion proceeds cannot be accessed in the first five years after conversion or under age 59-1/2 without a 10% federal penalty, 3) if tax rates are lower in the future, the benefits of the original conversion decision is diminished, and 4) the government could always change the rules.

In the case of larger estates, where there will be estate tax at the time of death, some planners recommend the Roth conversion to reduce the estate size, thereby reducing estate taxation while at the same time establishing an account that benefits from tax-free deferral that can be passed on to beneficiaries.

This is a cursory discussion of the new Roth conversion opportunity. Offering this opportunity means the government will receive more tax revenues now so you can understand their incentive to make the offer. If you think you want to consider a Roth conversion, I suggest getting professional help to determine the impact on your specific situation. We have found a lot of variance in the recommendation, depending on the situation.

Jerry Mosher, CFP® is a 30 year veteran of the financial planning industry and is president of Mosher & Ellis Financial Planning in Lafayette, California. He has been selected three times as one of the 150 best financial advisers for doctors by Medical Economics. Jerry may be reached at (925) 284-9470. Securities offered through AMERICAN INVESTORS COMPANY Member NASD/SIPC.

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