Retirement planning is an important part of managing money wisely. I think it’s necessary to build retirement through a long-term investment plan once certain financial goals have been met (emergency savings, out of debt, etc.). Retirement is what I like to personally think of as what will be my elderly working years. I want to be prepared to live on less and still work either part-time or on a volunteer basis to continue my mission of helping people manage money wisely.
Roth IRA Conversions in 2010
An article in Business Week, related to Roth IRA conversions recently grabbed my attention. Starting in January of 2010 there will no longer be an income limit on Roth IRA conversions. Currently, your AGI or Adjusted Gross Income cannot exceed $100,000 if filing single or jointly in order to convert your investment. You will also be able to spread income taxes owed on the withdrawal across 2 years.
Some benefits of the Roth IRA
As you may know, the Roth IRA can be an excellent retirement investment option. The key benefit with the Roth is tax free growth. You pay taxes going in today versus when you withdraw money in your retirement years. Another benefit is you can withdraw money without minimum required distributions given certain requirements are met.
Roth IRA conversions
What is a Roth IRA conversion? A conversion is withdrawing your investment from another retirement vehicle such as a 401k or traditional IRA. You pay income taxes on the amount withdrawn, and convert your investment over to the Roth IRA to gain the advantages mentioned above.
The article asks the question as to whether or not it makes sense to dip into 401ks, IRAs, and other retirement investment tools and pay taxes now by turning them into Roth IRAs. This is a good question as the approach could help save money in future taxes.
When does a Roth IRA conversion make sense?
Based on points made in the article and a quick review of Fidelity’s IRA Center, it may make sense in the following situations:
- If you have additional savings to pay the income taxes. Otherwise, if you use part of the investment withdrawn, you’re reducing the amount that can grow tax free in the Roth IRA.
- If you expect your tax rate to be higher in retirement. If you expect your tax rate to be higher in retirement you would obviously want to pay taxes on your investment now.
- Fidelity says if you have 10 years or more before you start taking withdrawals a conversion is likely to benefit you.
If the above aligns with your situation, one bit of advice from the article is to play with the numbers. If you only have partial savings to pay taxes, consider withdrawing and converting less.
In regards to paying the income taxes with savings, I don’t think it’s a good idea to pull this money out of emergency savings. I would keep that money in place and only use cash savings on top of 3-6 months of covered living expenses.
I recommend speaking with a financial and/or tax advisor about this new rule and how it directly affects your situation.
What are your thoughts on the new conversion rules?
Jason,
I read the Business Week article you linked to and disagree with the planner who was quoted. He advocates converting now and paying a marginal rate of 33%, ignoring the fact that there’s a zero bracket (the sum of STD deduction plus exemption) of $9350 next year. Then a 10% rate on the next $8375. He doesn’t spell out the rest of his math, I’d be curious what any pro-Roth advocate’s numbers look like. I can create example where it makes sense to convert, but his is not such an example.
.-= JoeTaxpayer´s last blog ..The Housing Boom and Bust =-.
Joe, thanks for commenting. Yeah, I think the BW article could have probably stood just fine without the example. It breezed through it and probably left a lot of people confused. That’s why I didn’t discuss it in my post. As I mentioned, I think the key is for people to get to the nuts and bolts of their situation with their tax advisor. Just curious, do you have any further information you can share to help others on the subject?
Jason, I’ve written quite a bit, when I comment I try not to post many backlinks, but here are my writings on the topic:
http://www.joetaxpayer.com/loving-that-roth/
http://www.joetaxpayer.com/more-roth-lovin/
http://www.joetaxpayer.com/roth-mania/
http://www.biblemoneymatters.com/2009/09/what-is-a-roth-ira-and-what-are-the-benefits.html
http://www.goodfinancialcents.com/roth-ira-amounts-maximize-wealthy/
(I know – I need to get a life. This is one of my hot topics lately. I’d like to help people avoid making a mistake.)
Joe
.-= JoeTaxpayer´s last blog ..The Housing Boom and Bust =-.
This is such a solid benefit of the Roth IRA that most people don’t know–you don’t pay when you take it out…and that’s when it’s worth a lot of money! Thanks for the enlightening post. People need to know more about Roth IRAs.
.-= Richard´s last blog ..How To Open A Roth IRA =-.