Conversions of Traditional to Roth IRAs

With the threat of higher tax rates in the future, now is a good time to research and inquire on ways to mitigate your own exposure to such rate increases.  One such way to protect income from taxes is to contribute to tax-preferred retirement savings accounts.  A couple examples of such accounts are Traditional and Roth Individual Retirement Accounts (IRA).

In general, contributions made to a Traditional IRA are deductible when made and when distributions are taken, such distributions are subject to income tax at the same rates that, for example, salaries and wages are subject to.  In contrast, contributions made to a Roth IRA are NOT deducted; however, qualified distributions (which includes original contributions and subsequent earnings) taken are not subject to income tax.

Starting in tax year 2010, generally all taxpayers are allowed to convert a Traditional IRA into a Roth IRA.  For those taxpayer’s who feel, given their own facts and circumstances, may benefit from the tax advantages of a Roth IRA over a Traditional IRA, the following lists items which should be considered before choosing to convert:

• In the year of conversion, a taxpayer will owe income taxes on the “conversion amount”. 
• Special Rule:  For conversions made in tax year 2010, the taxpayer can choose to spread the conversion amount evenly over tax year 2011 and 2012, paying any tax due on the conversion amount for those years.
• Income Tax Rates – what are the current income tax rates in the working years vs.  the expected income tax rates in the retirement years. 
• Roth IRA’s do not have a Required Minimum Distribution (RMD) rule unlike Traditional IRA’s that do.  Due to this, the Roth IRA allows a taxpayer more control over his/her effective tax rate by taking more or less money from the Roth IRA depending upon what income tax rates are in the retirement years.
• Estate Planning – a Roth IRA can be passed to heirs of an estate and such heirs can take distributions from the Roth IRA over his/her lifetime.  This provides for tax-free growth of the Roth IRA account over the heir’s lifetime, allowing for additional growth opportunities for the account.

For tax year 2010 and 2011, taxpayers under 50 years of age can contribute a maximum of $5,000 to a Traditional or Roth IRA (or a combination of the two).  If a taxpayer is 50 or older, the maximum contribution is $6,000.

There are several rules and restrictions surrounding Traditional IRA’s and Roth IRA’s.  Please consult your tax advisor for further details regarding these accounts.