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D. Frank Norton: Convert your traditional IRA into a Roth IRA and save

Posted: August 5, 2009 8:44 p.m.
Updated: August 6, 2009 4:55 a.m.
Want an IRA that has the following characteristics?
  • Withdrawals are tax free.
  • No required minimum distributions after turning 70.   
  • You can pull out funds when it is most advantageous for you, or not at all.
  • Your heirs don’t have to pay income tax on the withdrawals from their inherited IRAs.
The kind of IRA that I am describing is called a Roth IRA. Now most of us have steadily contributed to tax deductible  “traditional” IRAs and 401Ks. Although we got the tax benefit of this contribution in the year of contribution, we do have to pay tax on the dollars withdrawn in the year of withdrawal.

For some of us, given the significant dollars now sitting in our IRA and 401K accounts, these taxable withdrawals can be quite onerous tax wise.

Next year brings a unique opportunity for converting traditional IRAs and deductible 401Ks to a Roth IRA.  

Right now, if one was to convert his or her taxable IRA to a Roth IRA, the entire conversion amount would be taxable in the year of conversion.  

This conversion is allowed only if the adjusted gross income of the taxpayer is under $100,000. With the advent of 2010, those rules are changed dramatically.  

The adjusted gross income limitation is thrown out.  This means that a taxpayer with income greater than $100,000 can also effect a conversion of IRA funds to a Roth IRA.  

The taxpayer will also have an option as to when the conversion amount is to be taxed.  For 2010, the taxpayer can either elect to have all of the conversion dollars taxed in that year, or have the amount converted spread equally across your 2011 and 2012 tax returns, paying any resulting tax in those years. For example, if you convert $50,000 next year and choose not to declare the conversion on your 2010 return, you must declare $25,000 on your tax return for 2011 and $25,000 on your return for 2012.  

“Wait” you say. “Why would I want to be taxed on such big lump sums instead of spreading it out over many years of retirement distributions?”

There are many reasons for you to consider doing such a conversion, some of which were already stated at the beginning of this column. They are:

1. No required minimum distributions. You have control as to when the money is withdrawn.
2. No taxable withdrawal, even for heirs.
3. Tax rates may be going up in the future. By having our IRA funds taxed now at potentially lower tax rates just might be a great idea.
4. We can spread the tax hit over two years, instead of having to pay tax on the conversion all at once. This may keep us in a lower tax bracket also.

My next column here will discuss some conversion strategies to consider when taking advantage of this rule change.  So stay tuned.

D. Frank Norton is a money manager and financial planner in Santa Clarita. “It’s Your Money” appears Thursdays and rotates between a handful of the Santa Clarita Valley’s financial professionals. His column represents his own views and not necessarily those of The Signal.


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