Time is Running Out To Take Advantage of The Roth IRA Opportunity

Time is swiftly running out to take advantage of the unique opportunity for deferral of tax payments on Roth IRA Conversions in 2010.  In case you’re not up-to-snuff on this, in 2010 all taxpayers with traditional IRAs or qualified retirement plans that are eligible for rollover have the opportunity to convert the account (or part of the account) to a Roth IRA – and perhaps delay payment of the tax on the conversion to the following two years.  In addition, beginning in 2010 all individuals, regardless of income, can enact a Roth Conversion – whereas in the past there was an income limit on these conversions.

You have until December 31, 2010 to enact a conversion to take advantage of this unique, once-in-a-lifetime opportunity to defer taxes to 2011 and 2012.  This not to say that a Roth IRA Conversion makes sense in all cases… many times it is a poor choice, but in lots of cases it makes a lot of sense.  It all comes down to several questions.

The Questions

Tax rates now versus later. Since a Roth IRA Conversion subjects your tax-deferred funds to taxation today (or at best next year and the year following), determination of the effective tax rate on your conversion versus the planned payout many years later is an important factor.  If it is determined that the tax rate today is lower than you expect the rate to be in the future, then of course it would make sense to convert the IRA to a Roth now.  Then in the future, when the tax rates are higher, your Roth IRA funds will not be taxed.

But it’s not always so cut-and-dried – and specifically it is often the case that tax rates are not going to be lower in your retirement years.  But that doesn’t shut the door on Roth Conversion.

Source of funds to pay conversion taxes. One of the key items to address in a Roth Conversion is where you’ll get the money to pay the taxes.  When you convert funds from an IRA to a Roth, you must pay tax on the money that was taxable in the IRA.  If you have money from another source that you can use to pay the taxes, you’ll keep the converted funds that you deferred over time intact, rather than depleting the funds to pay tax.  Plus, if you’re under age 59½ you’ll also incur a 10% penalty on any funds that you take out of the account to pay tax.

But even if you don’t have funds from elsewhere to use for tax payment, you can still benefit from a Roth Conversion…

Deferral period after conversion. Whenever you plan to use the funds in the account (converted or left where it is in the IRA), will make a big difference in whether a conversion will pay off for you.  If you will need the funds immediately after the conversion or after a short period of time, your Roth account will not be able to grow enough tax-free to make up for the tax you had to pay on the conversion.

If, however, you are able to delay your need for the funds until later (even just a few years), it could pay off to do the conversion.

Putting it all together

All of these factors for your unique situation must be put together in order to determine if a Roth Conversion will work for you.  And the good news is that you can work out details on a conversion that might make sense for you later (after 2010), since the rule about income limitation has been lifted indefinitely (at least under current tax law).

But the question now is whether or not the Roth Conversion with the extra tax payment deferral is advantageous to you, in 2010.  It is, as you might have guessed, a complicated undertaking to fully understand the questions and how they might impact you.  If you need assistance in working through these questions – you can always give me a call.  I’ll be happy to help you work through the decisions to understand if it makes sense to put a conversion into play this year or not.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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