Roth ‘n’ Roll

Only 9% of Boomers are planning to make a Roth conversion in 2010, but 57% aren’t even aware of the opportunity.

There are lots of reasons to love the Roth IRA:

1. Withdrawals are tax-free;
2. There are no required minimum distributions;
3. Distributions aren’t included in the calculation that determines taxability of Social Security benefits;
4. The account retains it’s tax free status in the hands of your heirs.

Unfortunately, up until now, many of us have been unable to take advantage of these benefits. Individuals in higher tax brackets are prohibited from contributing to Roth IRAs and, previously, only those with income under $100,000 were allowed to convert their traditional IRAs into Roth IRAs. In 2010, however, the income ceiling for Roth conversions is permanently repealed.

Because a Roth conversion is a complex financial planning issue, you should take a look at your personal financial situation including what you think your future taxable income and tax rates might be before you convert. There are numerous free on-line Roth conversion calculators to help you with this like CalcXML.

A few things to keep in mind about a Roth conversion:

Conventional wisdom is that a traditional IRA is better if your tax bracket today is higher than what it will be in retirement. How many of you want to bet that will be the case if you are 10+ years away from retirement? Given our current political environment, do you think it is more likely for the top marginal rate to move to the Reagan years at 50%, the Clinton years at 39.6% or Bush 41 at 31%? My guess is we will go higher before we go lower than today’s 35%.

Assets converted to a Roth IRA are considered taxable income in the year of conversion but there is a special provision this year that allows you to spread the taxable income from a conversion over 2011 and 2012.

Understand that with a conversion you are accelerating the payment of future taxes in return for tax-free income later. Despite the presence of this tax liability, a conversion still may make sense if you can pay the tax from sources other than your IRA.

A neat way to reduce the negative tax impact of a conversion (and thus do well by doing good) is to make an offsetting charitable donation. By choosing to make a charitable gift of non-IRA assets in the same year as the conversion, you could pay a smaller amount in taxes by reducing your taxable income and (potentially) your marginal tax rate.

If you have charitable donations planned for future years, consider accelerating them into the Roth conversion year. My favorite vehicle for this is a Donor Advised Fund which you can set up through almost any financial services firm. A Donor Advised Fund allows you to make an irrevocable charitable contribution and receive an immediate tax deduction, but spread decisions about grant recommendations of desired charities over time as you see fit.

In a Roth conversion, as with most financial issues in this complex world we live in, there are traps awaiting the unaware. Make sure you address your personal situation with a professional who knows what they are doing before you commit to this, or any other, tax and financial planning strategy.

About the author

Michael Roberts wrote 3 articles on this blog.

Michael Roberts is an accomplished wealth management executive and attorney who brings to clients a strategic understanding of how trusts can be used to preserve and transfer wealth through taxefficient and effective intergenerational planning. He has over 20 years experience in the financial services industry, most recently as President of UBS Trust Company, N.A. Prior to that he was a Regional Managing Director of Personal Trust for Wachovia, responsible for more than 20 trust offices with assets of $11 billion.

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