Converting to Roth IRA may still make sense
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Anyone who hasn't switched their traditional individual retirement account to a Roth IRA by now has missed the window of opportunity to spread the tax payment over the next two years, but there are still advantages to doing the conversion.
Congress extended the Bush-era tax cuts through 2012, which gives retirement investors more time to do the Roth IRA conversion at the current tax rate, which will stay the same for at least the next two years.
"If you know or feel tax rates are going up or you know you'll be in a higher tax bracket later, a Roth IRA conversion now can make a ton of sense," said Robert Hapanowicz, president of Hapanowicz & Associates Financial Services, Downtown.
The whole idea is to pay taxes on a Roth IRA conversion when the tax rates are lowest, which could be now thanks to lawmakers voting late last year to keep income tax rates for everyone at every income level unchanged for two more years.
Many people who converted their traditional IRAs to Roth IRAs in 2010 did so with the expectation that the Bush-era tax cuts would expire this year and force them to pay a higher tax bill on the conversion.
But the Internal Revenue Service also gave taxpayers who converted in 2010 a one-time special advantage of spreading out the payment of taxes to 2011 and 2012.
What that means is with a $500,000 Roth IRA conversion, an investor could pay no taxes in 2010, recognize half -- or $250,000 in income -- in 2011 and pay taxes on the other half in 2012.
Roth IRAs differ from traditional ones in that withdrawals from traditional IRAs are taxed as ordinary income when the account owner reaches retirement age, while withdrawals from Roth IRAs are exempt from taxation.
The flip side is that contributions to a traditional IRA are deducted from the saver's income taxes and are allowed to grow tax-free during the accumulation stage. Roth IRA investors do not get that tax deduction.
Howard Davis, president of Davis, Davis & Associates, a Downtown accounting firm, said last year he would have recommended his clients in the highest tax bracket -- 35 percent -- pay the conversion tax on their 2010 return because of the possibility that the highest tax rates would go back to 39.6 percent in 2011 and 2012.
First Published February 1, 2011 12:00 am
