Thinking about a Roth IRA?

On January 1, 2010, all taxpayers became eligible to convert traditional IRA’s to a Roth IRA. A Roth IRA is individual retirement account from which all your withdrawals are tax-free as long as you have held the account for five years and are over age 59½.  This presents an excellent opportunity for taxpayers, who were previously not eligible, to reap the benefits of a Roth IRA.

Looking forward over the next few years, it is highly likely that Congress will increase income tax rates, especially the two highest income tax rates, in an attempt to offset record deficits and to pay off the national debt. By converting to a Roth IRA today, at lower income tax rates, you, in all likelihood, will convert future income and appreciation within the IRA to tax-free income at a relatively low tax cost.

There are many factors and variables associated with a Roth IRA conversion that should be considered before the decision to convert is made. In order to arrive at the desirable Roth IRA conversion amount, one must prepare several spreadsheet analyses to determine which factors will have the greatest impact.  In particular, the following factors have generally had the most impact on successful Roth IRA conversions:

1. Asset mix (i.e., qualified investments vs. non-qualified investments)
2. Size of traditional IRA
3. Time horizon
4. Current and future cash flow needs
5. Current income tax rates vs. projected future income tax rates
6. Wherewithal to pay the income tax with nonqualified investment funds

The new tax law allows taxpayers to re-characterize (undo) their Roth IRA conversions if either: (1) the taxpayer does not qualify to convert to a Roth IRA or (2) the conversion is not tax advantageous. In either case, if a taxpayer converts to a Roth IRA at any time during the current tax year, he/she will have until October 15 of the following tax year to re-characterize the previous year's Roth IRA conversion. This provision within the tax law creates a unique opportunity by taking the risk out of the conversion by giving the taxpayer the benefit of hindsight.

If you are interested in learning more about Roth IRA conversions and/or believe this is a viable tax planning strategy for you, please call us 419-891-1040 or email Sandi Towns, CPA/PFS, CFP® (or your William Vaughan Company professional) to discuss the particulars of your unique circumstances.