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Roth
IRA Conversions: Better Late Than Never? |
Congress
created a new retirement-saving vehicle that became effective
in 1998: the Roth IRA. Its primary advantage over a traditional
individual retirement account (IRA) is that, although you can’t
deduct your contributions and must pay income tax currently
on any rollover from an existing IRA, you pay no income tax
on qualified distributions. This means your money can grow tax
free -- not just tax deferred. Congress also offered a bonus
for taxpayers who converted (rolled over) their traditional
IRAs into Roth IRAs during 1998 only: They could spread payment
of the income tax due on the conversion over four years.
If you missed out on or couldn’t qualify for the initial
bonus of the four-year spread, could a conversion of your traditional
IRAs to a Roth IRA still make sense? Even though you will have
to pay all of the tax in the year of conversion, the answer
could well be "yes."
Can You Qualify For a Conversion?
Nothing else will matter if you cannot qualify for conversion.
Your adjusted gross income cannot exceed $100,000 to qualify.
(Note that the threshold for Roth IRA contributions is different
from Roth IRA conversions.)
Even if your income is typically more than $100,000, you may
be able to qualify in certain years. For example, if your business
has a losing year or you have retired, you may be able to qualify.
Talk to us about possible creative ways to defer or accelerate
income between years so that you may qualify for a Roth conversion.
The Age Factor
Because Roth funds build up tax-free over time, the Roth IRA
works best for young individuals. But younger people who can
qualify tend to have smaller balances in their IRAs and may
not be able to afford the tax as well.
However, even with small balances, conversion to a Roth IRA
is a good idea. You’ll be most likely to benefit from
conversion if you are young, can qualify for conversion and
can afford the tax.
A conversion is not as beneficial for an older person because
fewer years are available for the funds to build up tax-free.
Ironically, retired taxpayers often can more easily make the
conversion. They may be able to meet the income qualification
because they are no longer working, and they often can afford
to pay the tax on a substantial IRA balance because they have
larger amounts of savings outside of the IRA. If you are retired
and will not need some portion of your IRA funds to live on
and, even better, have sufficient funds outside the IRA with
which to pay the income tax, you are a prime candidate for conversion.
Building a Family Fortune with Your Roth IRA
While the Roth IRA can be effective as a wealth-building strategy
for you and/or your spouse if at least one of you lives long
enough (say 15 or 20 years), it can also be beneficial for your
heirs even if you don’t live that long. That’s because
the potential period of tax-free buildup is not limited to your
own lifetime.
While the Roth IRA is subject to the same distribution requirements
after death as other IRAs and qualified retirement plans, this
is when its benefits may prove to be greatest. Your Roth IRA
can continue to grow tax-free during your lifetime because there
are no required minimum distributions and for many years after
you die, because required distributions can then be based on
the life expectancy of a much younger child or even grandchild
beneficiary.
Running the Numbers
Before jumping into a substantial Roth IRA conversion, carefully
project its results and weigh the long-term potential benefits
against the current cash outlay needed to pay tax. Look at how
it works at different rates of return, too, keeping in mind
that some appreciation in value of the Roth IRA assets is key
to its benefit as a strategy.
Also, compare its value versus alternative use of the funds
necessary to pay the tax. These alternatives might include making
gifts to family members if you don’t have sufficient funds
to do everything at once.
‘Tis the Season for Roth Conversions
While many income tax planning strategies are best implemented
as year-end approaches, conversion to a Roth IRA is best done
earlier in the calendar year because it involves the creation
of taxable income. If your income would otherwise be the same
as last year (or higher), you will not need to pay tax on income
from converting a regular IRA to a Roth IRA until April 15 of
2002. And if the value of your IRA keeps growing, the amount
includable in taxable income is lower now than it will be on
a conversion later in the year.
If you would like more information on whether converting your
traditional IRA to a Roth IRA is a smart strategy for you and
whether this is the best year to do it — or if you have
other retirement or estate planning questions, please call us.
We’d be pleased to help you get the most from your IRAs
and their assets.
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