Wednesday, February 25, 2009

Take a Look At Tax Law When Converting An IRA

The News Tribune recently published a great article examining the tax laws surrounding the conversion of a Traditional IRA to a Roth IRA. You can check out a portion of the article below, but the full post can be found here.

Over the next two years, you are likely to see more people convert assets from Traditional Individual Retirement Accounts to Roth IRAs.

Three considerations make understanding the IRA to Roth conversion more important for many investors:

• Lower values of most IRAs as a result of the market correction.

• The prospect of increased taxes in our future.

• The elimination of an income limit in 2010.

With a Traditional IRA, when you take withdrawals of your contributions and earnings, they are subject to ordinary income tax. Also, once you reach 701/2 you are forced to take annual distributions. (These required minimum distributions have been waived for 2009.)

With a Roth IRA, as long as you’re over 591/2 and have held the account for five years, the assets grow tax free, there’s no tax on withdrawals and no requirement to take annual distributions if you don’t need the income. This way, more potential growth may be available for your later years or for beneficiaries of the account.

Determining whether or not to make this conversion can be complicated. You need to weigh the short-term consequences vs. the long-term impact. In order to make the conversion, you have to pay income tax on the amount converted. But if you can afford that hurdle, the long-term benefits may be worthwhile.

For many, a Roth conversion makes sense if you expect income tax rates, or those of your heirs, to rise. An increasing personal tax burden seems likely given the rapidly growing fiscal deficit due to bailout and economic stimulus packages.

There are different reasons driving Roth conversion decisions in 2009 and 2010. This year, investment declines during this recession have presented a more immediate opportunity. If your modified adjusted gross income is less than $100,000 in 2009 (filing jointly or single), you are eligible to make the move from Traditional to Roth IRA. And for many, the tax bill associated with the conversion will be significantly less than it would have been to make the same conversion at this time last year.

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