Incentive in 2010 to Roll a Traditional IRA into a Roth
By the StockBoxFinancial Team
March 12, 2008
Under current law and effective in 2010, Traditional IRA owners will be allowed to convert that IRA, of any amount, to a Roth IRA. Following are some of the advantages and disadvantages of such a conversion:
Advantages:
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You would pay income tax on the 2010 Traditional IRA converted into a Roth IRA as follows: 1/2 of the 2010 tax would be due in 2011 and 1/2 of the tax would be due in 2012. Example: You convert a Traditional IRA of $500,000 into a Roth IRA in 2010. Your income tax rate including the conversion of the $500,000 Traditional IRA into a Roth IRA would trigger a Federal income Tax liability approaching $175,000 (500,000 x 35%) or higher when state taxes are included. You would be required to pay the $87,500 of the Federal tax in 2011 and 87,500 of the tax in 2012.
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If the Traditional IRA were converted to a Roth IRA, the Roth IRA would grow tax free and could be withdrawn, according to Roth IRA rules, without any income taxes.
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After 2010 upon the death of the Roth IRA owner, the Roth IRA would be subject to estate taxes, as an asset of the decedents estate, but the Roth IRA would not be taxed twice, as a Traditional IRA may be, because income taxes were paid upon the conversion of the Traditional IRA to the Roth IRA.
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The younger the IRA holder is now, the more positive the impact, by making the conversion to a Roth in 2010.
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If your income tax bracket is expected to be equal or higher at retirement than it is now, you may benefit making the conversion to a Roth in 2010.
Disadvantages:
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You will be required to pay income taxes on the conversion at your 2010 income tax rate.
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The 2010 taxable income, do to the Traditional IRA conversion to a Roth, will likely be taxed at a higher tax rate than the normal income tax rate. Example: You have an IRA of $ 500,000. Your normal income tax rate is 25%. You make the IRA conversion in 2010 of $ 500,000, to a Roth IRA. This conversion will increase your tax rate to about 35% in 2010.
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You would pay income taxes in 2010 (by making the IRA conversion to a Roth), when you can delay them until later.
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Your IRA may be severely reduced by this conversion. Example: You have an IRA of $1,000,000 and want to convert it to a Roth IRA in 2010. This conversion will be taxed at 35% Federal and maybe at 5% State for a total of 40%. Thus, after the conversion, you will have reduced your IRA from $ 1,000,000 to $ 600,000.
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If you needed to withdraw funds from a Traditional IRA to pay for some income tax deductible expense, such as medical expenses, then the taxable income of the Traditional IRA withdrawal would largely be offset by the deductible medical expense and the withdrawal would be virtually tax free.
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If you expect to be in a lower tax bracket at retirement then you are in now, then you generally not would not benefit from the conversion.
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If you are older, you would generally not benefit from the 2010 conversion because your Roth IRA may not have as much time to grow after the conversion to make up for taxes previously paid
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Tax laws may change and the conversion may not be available.