Convert or not to convert? That is the question you should be asking yourself this year when it comes to making decisions about your traditional IRA.
If you are considering a conversion to a Roth IRA, it’s important to understand what the process entails.
Roth IRAs have many advantages, including tax-free distributions in certain circumstances, no required minimum distributions for owners, and income tax-free transfers to beneficiaries. Despite their attractive features, Roth IRAs have not been as popular as traditional IRAs. One reason is the income and filing status limitations that disqualify many individuals from being eligible to contribute to or convert their traditional IRAs to Roth IRAs.
Beginning in 2010, however, a change in the tax law allows you to convert your existing IRA to a Roth IRA, regardless of income level or filing status. If you convert your traditional IRA to a Roth in 2010, you will have the choice of including the entire conversion amount as income in 2010, or spreading the conversion amount between tax years 2011 and 2012.
Clearly, there is a Roth IRA conversion trade-off—if you convert to a Roth IRA, you will accelerate taxable income into an earlier year. On the other hand, a Roth IRA, unlike a traditional IRA, would enable both tax-free withdrawals and the avoidance of required minimum distributions—allowing the account to grow tax-free for a longer period of time.
There are a few items to consider in the decision of whether or not to convert to a Roth IRA:
•What are your current marginal tax rates and anticipated future marginal tax rates (for the next few years as well as in retirement)?
•Will the tax on the conversion be paid out of IRA assets or other assets? Do you have prior year tax carryforwards, such as net operating losses, that can offset the income from the conversion?
•What is your current age and expected retirement age?
•When will you need to take distributions from your IRA?
If you do convert to a Roth IRA and find that the account (or accounts) has not performed as expected—or your circumstances have changed—you can change your mind after the fact. Believe it or not, you have until October 15th of the year following the conversion year to re-characterize the account back to a traditional IRA and possibly try the conversion again the following year.
The Roth IRA is a powerful retirement and estate planning tool that has not been available to many people until now. Conversion to a Roth IRA is certainly something to analyze and discuss with your tax, legal, and/or investment advisor.
Content contributed by the Charlotte office of Elliott Davis, PLLC, an accounting, tax and consulting services firm providing clients the solutions needed to achieve their objectives in 10 offices throughout the Southeast. For more information, contact Dan Warren at 704-808-5210 or visit www.elliottdavis.com.