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Losey: To Roth or Not to Roth?

That is the question being contemplated by millions of American’s and their tax preparers. In case you haven’t heard, beginning January 1, 2010, any investor may convert their traditional IRA to a Roth IRA. Unlike prior years where where there were income limitations, no IRS income limits will apply or stand in the way of the conversion starting in 2010.

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So why is this a big deal and should you convert?

Unlike a traditional IRA that grows taxed deferred with withdrawals being taxed as ordinary income, a Roth IRA grows tax-free and when you take money out all withdrawals are tax-free too (assuming you have held your Roth IRA for 5 years or longer and are age 59½ or older).

Unlike a traditional IRA which requires mandatory minimum distributions (by April 1st of the year after the year you turn age 70½), under current law no mandatory withdrawals are required in a Roth. This favors younger investors, those with a long investing time horizon, people in a higher tax bracket, or those that expect to be in one later.

Baby boomers and older investors have good reason to consider a Roth IRA too especially if they think they won’t have to take money out of their IRA when they retire. Under current tax laws, converting to a Roth, coupled with careful estate and tax planning, could very well save an investor tens of thousands of dollars by reducing the size of their taxable estate. Additionally, with proper beneficiary planning, a surviving spouse could have many years (even decades) of tax-free growth.

When a spouse inherits your Roth and then names a child as beneficiary, that heir has the choice to make minimum withdrawals according to his or her life expectancy, all while the assets continue to compound tax-free. Assuming junior doesn’t blow the money in the year inherited and is a good steward of the money, it could potentially last for decades across multiple generations. Under current IRS law, withdrawals from an inherited Roth IRA are not subject to income tax.

The downside of changing from a traditional IRA to a Roth IRA is that the IRS treats the conversion as a taxable event.

In short, you’ll need to pay taxes on the entire amount of the conversion. One reason for all the hoopla surrounding 2010 is that the market and IRA values are still down from their highs now. If the markets and your IRA don’t rebound, this translates into having to pay less in taxes on the conversion. Another huge benefit of converting in 2010 is that you can pay the IRS the taxes due over your 2011 and 2012 tax returns. Ultimately, you wouldn’t have to pay the IRS your final installment until April 15, 2013 (or your tax filing deadline for year 2012).

Bill’s Bottom-line: At the end of the day, your financial situation is unique and different just like your fingerprints. For some people it may make sense to convert. For others it may not. Consult a trusted accountant, CPA, advisor or enrolled agent before you do.

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Bill Losey, CFP®, America's Retirement Strategist®, coaches women and couples nationwide with their retirement planning and investment portfolios. Bill is the author of Retire in a Weekend! The Baby Boomer’s Guide to Making Work Optional and he also publishes Retirement Intelligence®, a free weekly award-winning newsletter.
You can learn more at www.MyRetirementSuccess.com.