Roth IRA Conversions

Roth IRAs differ from traditional IRAs in that the Roth contribution is with after tax money, and not pre-tax money. In addition, all growth is tax free and not tax deferred, as it is with traditional IRAs. Conversion from traditional to Roth IRAs had been limited to single and married filers who have an adjusted gross income of less than $100,000.  In January of 2010 the $100,000 AGI definition limit went away making the Roth conversion available to everybody.   Before running to do a conversion, we think there are a number of items to consider.

1. When to do a conversion The amount of the conversion is added to your income, and all tax is due with one exception. If the conversion to a Roth is done in 2010 ONLY, the tax may be spread over two years. The tax rate is only guaranteed for that specific tax year. If you do a conversion in 2010, and the tax rates change (increase, most likely), you will pay taxes at the new (higher) rate.
2. Make sure you calculate with relative certainty your amount of taxable income before you do a conversion. Our tax system is a marginal system,definition and you would not want to do any conversion which would tax the amount of the conversion at a higher level. This can be easily accomplished by speaking with a CPA, or by the use of one of the many income tax software programs which are available. The ultimate goal would be to have the conversion amount extend to the highest level of your LOWEST possible tax bracket. For instance, if you are a single taxpayer, and the highest level of the 15% bracket is having taxable income of $61,000, and your income is $40,000, then the conversion amount should be $21,000, making sure that nothing is taxed at a rate higher than 15%.
3. The older you are, the less you should consider doing a Roth conversion.  Please try and follow along with this logic. Under the traditional IRA rules, all funds accumulate tax deferred and are fully taxable when withdrawn. If you are 55 and have a traditional IRA worth $100,000 and decide in 2010 to do a full Roth IRA conversion, the full $100,000 will be added to your taxable income. Let’s assume it will be taxed at 25%, meaning you would owe $25,000 spread over two years to satisfy your tax obligation. By doing this, you are “front loading” your tax obligation, and not deferring it until age 70 ½, at which time you must begin withdrawing funds using the government table (more information).   

   Required Minimum Distribution Table

   Required minimum distribution (RMD) table shows the factors consumers over the ages of 70 ½ must follow in determining the appropriate amount that must be removed from their IRA or other qualified plan during a calendar year.

   Age	Factor
   70	27.4
   71	26.50
   72	25.6
   73	24.7
   74	23.8
   75	22.9
   76	22.0
   77	21.2
   78	20.3
   79	19.5
   80	18.7
   81	17.9
   82	17.1
   83	16.3
   84	15.5
   85	14.8
   86	14.1
   87	13.4
   88	12.7
   89	12.7
   89	12.0
   90	11.4
   91	10.8
   92	10.2
   93	9.6
   94	9.1
   95	8.6
   96	8.1
   97	7.6
   98	7.1
   99	6.7
   100	6.3
   101	5.9
   102	5.5
   103	5.2
   104	4.9
   105	4.5
   106	4.2
   107	3.9
   108	3.7
   109	3.4
   110	3.1
   111	2.9
   112	2.6
   113	2.4
   114	2.1
   115 and over	1.9

   Under current rules, the first year’s withdrawal percentage is 3.63% of the full account value. It may make more sense to allow the funds to accumulate tax deferred and postpone the tax liability to years in the future when inflation will render the dollar being worth less than it is today?? We believe this logic holds for “older “taxpayers, as they will not have the time to allow the funds to compound to make up for the value lost due to the tax liability paid.