As golf managers, we spend much of our time at our golf course facility ensuring things run smoothly. There is the other side of our lives where we deal with the issues of everyday life, including financial matters. This is the first of several articles I intend to develop pertaining to financial planning issues you may be dealing with now or in the future. Since US Golf Managers Association membership covers a broad spectrum of ages and occupational arrangements, I will endeavor to keep the articles general but informative. For more specific information, I will always suggest you contact your advisor, in whatever discipline the question involves (i.e. investments, insurance, taxes, etc.). However, due to the significance of 2010 and the Roth IRA Conversion opportunity, I thought this is a timely topic to cover first.
The Roth IRA differs from a traditional IRA in the fact that contributions are made with after-tax dollars (not deductible), the account grows tax-free, and distributions (within the IRA rules) are tax-free. Maximum contributions to the Roth IRA in 2010 are $5,000 (or 100% of earned income), plus an additional $1,000 catch-up provision for anyone 50 years of age or older. Contributions to the Roth can be made at any age, provided they have earned income equal to or greater than the contribution amount. These are the very basic principles of the Roth, but then we have the conversion opportunity.
Traditional IRA Basics
The Traditional IRA gets its funding from contributions made with pre-tax dollars (or tax-deductible), or from rollovers of pre-tax retirement accounts such as 401K, 403b, Thrift Savings, etc. Because these accounts have never been taxed, and will grow tax-deferred until distributions commence, every dollar distributed will be taxed in the future. The amount of tax won’t be known until we reach that point in time, and many believe we will see higher taxes in the future.
One way to eliminate the unknown of future taxes is to utilize the Roth IRA conversion privilege. In 2010, that opportunity is now extended to anyone with tax-qualified holdings in IRA accounts. Retirement accounts with previous employers can be rolled into IRAs and converted to Roth IRAs, as well. Under prior law, taxpayers with incomes (adjusted gross) above $100,000 were not eligible to convert Traditional IRA to Roth IRA. Additionally, if a conversion was available, the full conversion amount had to be claimed in the tax year the conversion took place. Depending on the size of the conversion, it could substantially affect the overall tax liability for that year.
The 2005 Tax Increase Prevention and Reconciliation Act (TIPRA) repealed the income limitation for Roth conversion starting January 1, 2010. The act also allows conversions for taxpayers who are married but file separately. And, it also gives the taxpayer the option to report the conversion amount in 2010 (as previously), or at the taxpayer option, to report half the conversion amount in tax year 2011 and the remaining half in 2012.
Effectively, the conversion takes place in 2010, but the tax consequences can be delayed To the 2011 and 2012 tax years.
Roth IRA conversions can be a good opportunity for many, but not everyone. Here are a few points to consider:
1. Because you pay taxes on the conversion, doing so is most effective if your tax
bracket is lower now than it will be in the future. While tax increases are a political “hot potato,” given the size of the federal deficit and accumulated cost of economic stimulus, it is difficult to believe we won’t have income tax rate increases sometime in the not too distant future.
2. You need a reasonable amount of time for accumulated earnings to offset and
justify the conversion. What is a reasonable time frame? A minimum of five years, but the longer the better. The Roth conversion is especially attractive if the money is planned to pass on to heirs.
3. Paying the taxes on the Roth conversion. Ideally, you need to be in a position to
pay the taxes with money not currently in the Traditional IRA. Using Traditional IRA dollars to pay for the Roth conversion creates additional tax liability for the amount withdrawn from the Traditional IRA. In addition, if you are younger than 59 ½, the withdrawal would be treated as an early distribution subject to a 10% penalty.
Converting to a Roth IRA is not for everyone, but many should consider it. To find out whether a Roth conversion makes sense for you and to take advantage of these changes in 2010, talk to your tax or financial advisor. If you want to do more research on your own, go to your favorite search engine, type in “Roth IRA Conversion,” and you’ll get a plethora of information and tools.