As we near the end of 2010, a lot of people have already done Roth IRA conversions, and lots of others are questioning if a Roth IRA conversion in 2010 is the correct move for them.
Why are Roth IRAs in the news so much this year? Before, Roth IRA conversions were limited to people who earned under a particular income limit ($100,000). A change in the guidelines, effective as of January 2010, removes the income limit which means more individuals are allowed to to convert from normal IRAs to Roth IRAs.
Part of this new rule is the flexibility to pay the taxes from any conversions carried out in 2010 over a couple of years. Rather than having to pay out the taxes from the conversion all on one tax return, the IRS is allowing you to pay out half in 2011 and then half in 2012.
Even though the brand new regulations may seem too good to pass up, you ought to check out the situation very carefully before jumping into a Roth conversion in 2010. Just because you could convert to a Roth does not imply you should do a conversion, at least not straight away.
Before you make a decision on whether to convert or not, listed here are a few fundamentals about traditional and Roth IRAs you should be well aware of:
Traditional IRAs
- Cash put into traditional IRAs is tax deductible (income limits apply if you're covered by an employer sponsored retirement plan)
- Withdrawals from traditional IRAs are actually taxed at your ordinary income tax rate, so in case you are in the 15% tax bracket you'll pay out 15% on the amount withdrawn, in the event you're in the 28% tax bracket you will pay 28% on any distributions, etc.
- The IRS requires you to take a minimum amount out (primarily based on your age and the account balance) after age seventy 1/2.
Roth IRAs
- Contributions to a Roth IRA are not tax deductible.
- You may not be allowed to contribute to a Roth IRA when your earnings is above the limits.
- Qualified withdrawals (must be at least age fifty nine 1/2 and have had the Roth for at least five years) aren't subject to income tax.
- In contrast to traditional IRAs, you are not required to take money out of your Roth IRA when you reach age 70 1/2
Should You Do a Roth Conversion?
You need to consider converting to a Roth IRA if:
- You anticipate to be in the same or higher tax bracket once you retire (or when you'll need the funds),
- You will not need the money you convert for five years or more, and
- You could afford to pay off the taxes on the conversion without dipping into your retirement savings.
It is important to note that just because you can convert to a Roth IRA does not imply you need to convert to one. You should consult with a financial or tax expert to find out if a Roth IRA conversion is right for you, since each situation is different. A Roth conversion in 2010 might not make sense for you, but a conversion in future years might make sense if tax laws change or your own situation changes.
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