File this one under, “Check with your financial planner and tax adviser before taking action.”
So now that the Lebron’s choice episode is behind us, we can focus on another reason why 2010 is a unique moment in our financial lives. This year there is a moratorium on the Roth IRA rules. If you are in a higher tax bracket, you’ve been shut out of the Roth IRA party…until now. This year, ANYONE can convert an existing IRA into a ROTH IRA. There are 2 major consequences to doing this:
- Whatever portion of the balance you convert will be considered taxable income for this year.
- The balance you convert will be able to grow and compound into the future, and when you go to withdraw this money, you will do so TAX FREE
A Standard IRA (Individual Retirement Account) is an account that individuals can contribute to annually up to a certain amount. This contribution becomes a tax deduction for that year, but as the account grows over time, the future withdrawals are taxed as income on the year they are drawn upon. So there are some advantages to having these accounts as tax shelters in the near term.
A “ROTH IRA” is an account that is NOT an immediate tax shelter, as the money contributed to this account is done so post tax. BUT the key feature to this account is that as it grows over time, you will NOT be taxed at withdrawal. So you can see how for someone in their late 30’s or even late 40’s, being able to convert some or all of this balance can make a major difference in their retirement assets. Obviously, the older you are, the less time you have to benefit from compounding interest, and the reason to make this conversion may not be super compelling.
By making a conversion from standard to ROTH IRA, the tax bill that results can be paid over the next 2 tax years I believe. For best results, the tax bill should be paid from a source other than the IRA itself. You want to leverage as much of the benefit as possible by creating as much Tax free money as possible. Giving the account itself a “30% haircut” right off the bat will be VERY VERY VERY costly. Do the math.
Let’s all take a page out of the Lebron James playbook and create a big pile of money for ourselves and our families!
Again, be sure to consult your tax professional before making this conversion to be certain you are making the right choice. I am always happy to recommend my clients talk with Grant Folske here in town at RF Associates LLC.