Roth IRA Conversion Opportunities
Dear Clients & Friends:
If your traditional IRA has dropped
in value and you expect to pay higher federal income tax rates in future years,
now might be a very good time to consider converting all or part of your
traditional IRA balance into a Roth IRA. Here’s why. If you convert, it will
trigger a current tax hit on the amount you convert. But, with your traditional
IRA balance at a depressed level (and possibly your overall income too), the tax
hit will be less. After the conversion, your new Roth IRA balance can build up
federal-income-tax-free. Eventually you can take tax-free withdrawals after age
59½ when your marginal tax rate may be higher (perhaps much higher) than it is
Roth Conversion Basics
A Roth conversion is treated as a
taxable distribution from your traditional IRA because you’re deemed to receive
a taxable payout from your traditional IRA with the money then going into the
new Roth account. So, a conversion will generally trigger a current federal
income tax bill (and maybe a state income tax bill too). But the following
positive factors may outweigh the current tax hit.
- The conversion tax hit is reduced if the value of your traditional
IRA has been beaten down by stock market losses.
- Today’s tax rates might be the lowest you’ll see for the rest of
your life. If so, converting would allow you to completely avoid higher future
federal income tax rates on the entire post-conversion increase in the value of
your Roth account.
The Roth conversion privilege is not
available to everyone this year. For 2009, it’s only available if your modified
adjusted gross income (not including any additional income triggered by the
conversion itself) will be $100,000 or less.
2010, the $100,000 restriction is scheduled to completely disappear, which will
allow all individuals to take advantage of the Roth conversion strategy no
matter how high their income. If your income level prevents a 2009 Roth
conversion, you can do one in 2010. And 2010 is almost here!
You Can Reverse an
Ill-advised Roth Conversion
Another great thing about the Roth
conversion strategy is you can always change your mind well after the fact.
Believe it or not, you have until October 15 of the year following the
conversion year to recharacterize (unwind) your converted account (or accounts).
For example, say you convert two traditional IRAs into Roth accounts in early
2010. Later next year, the values of the converted accounts plummet due to poor
performance of the investments held in the accounts. In this bleak scenario, you
would pay 2010 income tax on value that later disappeared. Bad idea! Thankfully,
however, you have until October 15, 2011 to recharacterize the two converted
accounts back to traditional IRA status. It’s as if the ill-advised conversions
never happened. So, you won’t owe any 2010 income tax on the now-unwound
Low current tax cost for converting
plus the chance to avoid higher future tax rates on income and gains that will
accumulate in your Roth account as the economy recovers (we hope) may add up to
the perfect storm for the Roth conversion idea. That said, please contact us before
pulling the trigger. There are a number of important variables to consider, and we would
welcome the opportunity to work with you to ensure a well-informed and
Please call us at (510) 797-8661 if
you have any questions or comments.