Financially speaking, the country is facing a lot of uncertain times when it comes to retirement and estate planning as the year progresses. There are a lot of questions about investments, particularly with the increasingly popular Roth IRA. It is becoming a popular choice for those looking for retirement accounts and for 2010 the incentives to convert old accounts to a Roth IRA are big.
There are many factors that go into deciding which type of retirement account is best. The Roth IRA has become popular because most people who choose it will end up with more money down the road than if they were using another form of retirement account. Below are some of the tax benefits to take into consideration when making the decision to switch.
Roth IRA Tax Benefits
Investment Earnings Avoid Taxation:
This is the main advantage of using a Roth IRA. Even though the contributions are made with after tax money, the withdrawals are tax free if you meet certain conditions (withdrawals are made after 59 and a half and account is 5+ years old). The disadvantage to this is that you will not get a deduction when you contribute to an IRA as you do with some other investment accounts.
Avoid Early Distribution Penalties on Certain Withdrawals:
The Roth IRA does not have as many limitations on taking early distributions as other forms of retirement accounts. The Roth IRA has certain exceptions that allow funds to be withdrawn from the IRA without penalty. The following are the exceptions to avoid the 10% early distribution penalty: disability of IRA owner, death of IRA owner, series of equal periodic payments after life expectancy of IRA owner, funds used to pay non reimbursable medical expenses, funds used to help pay for first-time home purchase (10K max), funds used to pay health insurance premiums when unemployed, funds used to pay education expenses, and funds used to pay IRS back taxes after a levy is placed on an IRA account.
No Minimum Distributions After a Preset Age:
This means that funds do not have to be withdrawn from a retirement account after a certain age and funds can stay in there and continue to grow and continue to grow on a tax free basis. Other traditional plans require distributions at the age of 70 and a half. With the Roth IRA, you do not need to take out the money and can leave it to your beneficiaries.
No Age Limit on Contributions:
Unlike other forms of retirement accounts, a Roth IRA can be setup at any age. Some forms of retirement accounts set a maximum age to make contributions; with a Roth IRA you can still set it up and start making contributions at 100 years of age.
There is no doubt that a Roth IRA is an excellent alternative to the most traditional forms of retirement accounts. 2010 is special because the rules have been tweaked in order to make it easier to convert other retirement accounts to a Roth IRA and have made it available to a larger percentage of Americans. Below are some factors that are specific to 2010 that will help influence your decision to do a Roth IRA conversion in 2010.
2010 Conversion Rules for the Roth IRA
Income Limit Conversion Rules:
If you are filing married or as an individual, the adjusted gross income level of $100,000 will no longer exist for the 2010 conversions. High wage earners may want to take advantage of this opportunity to convert money into a Roth IRA now and allow it to grow tax free as they are headed into their retirement years.
Tax is Not Due in 2010:
Throughout 2010, you will be able to convert to a Roth IRA at any time but the income claimed on the account can be tax deferred until 2011 or 2012. The IRS is expecting people to take advantage of this situation and has devised a special process for how the tax will be paid. You can claim 50% of the conversion amount as income in 2011 and the other 50% in 2012. This will only be allowed in 2010 and in following years the taxes must all be paid in full the following year. If you choose to pay taxes over the two year period, the tax rate is determined by the year. Should your income go up considerably, you will be paying more taxes in later years.
Convert 401Ks as Well as Traditional IRAs:
During the 2010 conversion, you can convert both traditional IRAs (what is an IRA account?) and any old 401ks or other retirement plans you have from a previous job. This may be the prime time to convert all accounts over to a Roth IRA.
Conversion Cut Off Date:
Remember that if you plan to convert any old retirement accounts, 401ks or traditional IRAs, you only have until December 31, 2010 to make the move. If you find that you are still unclear about how to or if you should proceed with converting to a Roth IRA account, you can seek the assistance of a tax professional to see how it would affect you based on your own financial situation.
The Roth IRA conversion benefits that are offered for 2010 are a big deal! 2010 opens the door for more individuals than ever before to optimize their retirement accounts through a Roth IRA and take advantage of all the benefits that they offer.
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{ 8 comments… read them below or add one }
The question that remains – with all the talk of people not saving, how many are saving enough that the small withdrawals each year after retiring will actually put them into a higher tax bracket?
In today’s dollars it would take over $2M in pretax accounts to create annual withdrawals high enough to simply max out the 15% bracket.
Thanks for writing this article Christian PF! I am planning on going to graduate school this fall, and am trying to decide if I should convert my Rollover IRA (formally my 401k with my employer) to a Roth IRA. However, since my income will be decreased significantly, I am still working through if the benefits of a Roth IRA would be worth devoting all of my funds to paying the taxes on in 2011-2012. Thoughts?
@MPFJ
If you look at historical tax rates in the US, our current rates are ridiculously low and to me it seems that it is a sure thing that we are going to see much higher tax rates in the future, so I am going to be converting everything to a ROTH. As far as paying taxes, there are a few ways to minimize the huge tax hit all in one year… check out this article…
http://christianpf.com/convert-traditional-ira-to-roth-ira-2010/
MPFJ – the lower income makes a conversion a potentially good idea. But not if it prevents you from new saving. Does the new employer offer a 401(k)? Does it have a match? You see, the choices multiply up pretty quickly.
First – A Roth 401(k) with match. (If you are in a lower bracket, the pretax 401(k) has less benefit for you.)
Second – Pretax 401(k) w/match (If Roth 401 not available, but you get match, go for it)
Third – (If no matching) – use a Roth IRA to put away $5K.
(I understand you’re going to grad school, but even part time work may have a 401 available)
A Roth 401k with match though will require that the match go into a traditional 401k account though right?
I agree. With huge deficits it seems that taxes will only increase in the future.
This is May 17, 2011. Do these Conversion Rules still apply today?
The income limit for those wishing to convert from traditional to Roth continues. The option the spread over future years was a one time 2010 deal. You now report the income in the same year as the conversion.