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November letter to clients
November 1, 2009
Dear Clients and Friends,
November’s Alert lead article is Year End Tax Planning Strategies. It deals with tax savings opportunities that need action before year end. However, in this letter we will explain an exciting tax strategy that you must wait until 2010 to utilize. It pertains to converting your traditional IRA to a Roth IRA.
New Rules for 2010
A change in the Roth regulations will allow families regardless of their income to convert their traditional IRA to a Roth IRA beginning in 2010. The current income limit is $100,000 which leaves many working families above the income limit.
The advantage of a Roth IRA over a traditional IRA is that withdrawals from a traditional IRA are subject to current income tax, whereas withdrawals from a Roth are tax free. Another advantage is that a traditional IRAs require withdrawals to start when the owner reaches age 70 1/2. With a Roth, there is no time limit as to when distributions have to start. If you choose not to withdrawal funds from your Roth during your lifetime, the entire account passes to your heirs who may withdraw the funds tax free. Roth IRAs give you more flexibility to use the money when you need it.
There is one drawback to converting your traditional IRA to a Roth. You must pay income tax at your current income tax rate on all the funds you convert to a Roth. The tax must be paid with existing savings because you cannot use your IRA money to pay the taxes. Consequently, some income tax planning needs to be done before making the conversion.
You must hold the Roth for at least 5 years after the conversion before you can start withdrawing any of the money that is earned in the account. You can with withdraw the original amount with no taxes or penalties after reaching age 59 1/2.
Conversion Planning Techniques
When should you make your conversion? As soon as possible after January 1, 2010 if you’re investing in stocks and you anticipate the market to go up. If you wait and the market goes up, you are taxed on all the gains when you convert. Once your money is in the Roth, all gains are tax free.
What if you can not afford to convert all your traditional IRAs to a Roth because you do not have sufficient savings? That’s OK. It doesn’t have to be all or nothing. You can spread the conversion out over two or three years to make paying the tax a little easier. Keep in mind that the conversion amount will be subject to the income tax rates in the year of conversion which may be higher than current rates. For 2010 conversions only, clients can elect for Federal income tax purposes to spread the income triggered by conversions evenly over 2011 and 2012. Without the election the taxpayer will pay all the tax in 2010, perhaps a good idea if your income was down for the year.
The new conversion rules may not be for everyone. If you anticipate being in a lower tax bracket when you retire, doing a conversion is not for you. You would be paying at a higher tax rate now than when you withdraw the funds at retirement.
As you can tell, there isn’t an easy answer to the question of whether or not you should convert your traditional IRA to a Roth. If you would like to discuss converting your traditional IRAs to a Roth with one of our tax professionals, please contact any of our offices and we will be happy to help you.
Sincerely,
SCHLENNER WENNER & CO.
Certified Public Accountants
& Business Consultants
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