With the lure of tax-free distributions, Roth IRAs have become popular retirement savings vehicles since their introduction in 1998. But if you’re a high-income taxpayer, chances are you haven’t been able to participate in the Roth revolution. Up to this point, your ability to contribute directly to a Roth IRA, or convert an existing IRA to a Roth has depended on your income level. Well, that’s about to change.
In 2006, President Bush signed the Tax Increase Prevention and Reconciliation Act into law. Starting in 2010, a specific provision in the law allows anyone to convert a traditional IRA to a Roth IRA regardless of their income level. In addition, if you make a conversion in 2010, for tax purposes, you’ll be able to report half the income from the conversion on your 2011 tax return and the other half on your 2012 return. Even though these new rules don’t take effect until 2010, there are steps you can take now if you want to maximize the amount you can convert. If you aren’t doing so already, you can make the maximum annual contribution to a traditional IRA, and then convert that traditional IRA to a Roth in 2010. Please note, if you are planning to convert to a Roth IRA and you have made any non-deductable contributions to your IRA, special rules apply so be sure to consult a financial planning professional.
Given the decline of asset values over the past 12 to 18 months, the idea of being able to convert retirement accounts to a Roth next year is particularly appealing. Because converting to a Roth IRA is a taxable event — with the trade-off being that the Roth will continue to grow tax free, but withdrawals will be tax free — upon conversion, and the tax due is dependent on the value being converted — the lower the value, the smaller the tax!
For those who have all of their retirement assets still in 401(k)s or other qualified plans and do not have an IRA, there are provisions for you as well.
Before 2008, you couldn’t roll from a 401(k) or other eligible employer plan directly to a Roth IRA unless the dollars came from a Roth 401(k) account or a Roth 403(b).
In order to convert your employer plan into a Roth IRA, you first needed to roll the funds over to a traditional IRA and then (if you met the income limits and other requirements) convert the traditional IRA to a Roth IRA.
The Pension Protection Act of 2006 streamlined this process. Now, you can simply roll over a distribution of non-Roth dollars from a 401(k) or other eligible plan directly (or indirectly in a 60-day rollover) to a Roth IRA. You’ll still need to meet the $100,000 income limit for 2009, so it makes sense to wait until 2010 to implement this strategy.
Is a Roth conversion right for you? The answer to this question depends on many factors including your income tax rate, the length of time you can leave the funds in the Roth IRA without taking withdrawals and how you’ll pay the income taxes due at the time of the conversion. A financial planning professional can help you to determine the best course of action for your situation.
Michael T. Ohlman, a senior vice president, financial planning, is in the Bradenton/Lakewood Ranch office of Raymond James & Assoc., Inc. He can be reached at (941) 907-0168.