SHOULD YOU CONVERT YOUR IRA TO A ROTH ?
I received a random call about the new opportunity to convert a traditional IRA to a Roth IRA. The person said “I am going to convert my IRA to a Roth before the end of the year, what do you think”? I asked him why? His response was “the person at the bank told me if I convert I can have a tax-free income for retirement”. While that might be true, there are tax and other issues that need to be addressed before making such a decision. But, and this is a BIG but, if you are over age 59 1/2 and you have the $$$ to pay the tax upon conversion, converting before the end of the year makes perfect sense.
The 10 following issues should be addressed before converting
- Possible Increase in Current Federal & State Tax Brackets- Be aware that any money you convert from your traditional IRA into a Roth IRA could increase your tax bracket.
- How are you going to pay the taxes? – Are you going to pay these taxes from earned income, such as wages, interest payments, or dividends? Would you have to take distributions or loans from your 401k plan (terrible idea)? Would you sell some of your long-term investments to pay the taxes (another terrible idea and could cause more taxes)? If you are thinking of paying the tax from the Roth conversion you are defeating the purpose.
- You Might Have to Pay Estimated Tax Payments- If you receive a significant increase of taxable income and there is no withholding, you might need to make quarterly estimates to the IRS. Failure to make timely estimates could result in penalties and interest.
- Your Medicare Part B Premium Could Increase- Most people in 2009 paid a monthly premium of $96.40 for their Medicare B premium. However, some paid a higher premium because Medicare B premium is based on your income. A Roth conversion could cause your total income to rise, which would increase your modified adjusted gross income (AGI). Therefore, this could cause your Medicare part B premium to increase as much as hundreds of dollars a month. However, this would only be for a year or two.
- You could lose Personal and Itemized Deductions-As your Adjusted Gross Income (AGI) increases above certain amounts; this could cause a reduction or elimination of certain itemized deductions and personal exemptions.
- Eligibility for college financial aid and scholarships An increase in a parent’s income could reduce the eligibility for their children for financial aid and scholarships.
- Tax credits – Tax deductions help reduce your taxable income. A tax credit reduces your tax liability dollar for dollar. However, many of these tax credits are based on your adjusted gross income (AGI). In some cases your tax credit could be reduced or carry forward to the next tax year.
- You might be subject to the alternative minimum tax (AMT) – The AMT is sort of another tax system. ???
The 5 following issues could benefit you.
- Low Tax Bracket- With unemployment over 10% many people could fall into a lower tax bracket. This could be a good opportunity in a hopefully short term low tax bracket to convert your traditional IRA to Roth. You might want to pay all the taxes in 2012 to take advantage of a low tax bracket. Talk to your accountant.
- Bad Business Year- You might be self-employed or own a corporation, where you have some big losses for the year. Those losses could help offset some of the taxes that could be owned on a Roth IRA conversion.
- No Required Minimum Distributions (RMD) –Individuals over 70 ½ usually must take required minimum distributions (RMD’s) from their traditional IRA. However, in a Roth IRA there are no 70 1/2 RMD requirements.
- Increase Children’s or Grandchildren’s Inheritance- Buy paying the taxes now on the Roth conversion, your children and grandchildren could inherit your Roth IRA account without having to pay income taxes.
- You Can Get A Do Over- If you account declines in value after you convert, the tax law allows you to recharacterize your account. Meaning you can switch your Roth IRA back to your Traditional IRA. Notes: separate accounts, 30 days after and file extension
We are currently working with a consultant to develop a platform for reps to do Roth Conversions. We feel the over 59 1/2 market is getting misguided information on the plusses for conversion. In 2013, ISN will be at the forefront of advisors who lead the charge for “GOING TO ROTH!” Call us today.