I’ve been fielding a lot of inquiries lately about Roth IRA tax planning for the future. Let me do my best to explain who should be doing what in terms of Roth conversions for 2010. Let me preface this by saying none of this is an exact science. There are all sorts of moving parts in the tax code and naturally we have no clue where tax rates are going after 2010. We do know they are not changing for 2010 so any planning we do over the next 12 months or so should be for 2011 and beyond.
What I think is likely for 2011 is that marginal tax rates will increase, specifically for small businesses and those earnings over $250,000. It seems inevitable that rates move higher given the level of government spending taking place right now to counter the recession. I don’t believe in the extreme tax hikes some are talking about but I think the marginal rate for the highest income earners will jump from 35% to somewhere around 40%. Any higher than that and you’ll start hearing talk about higher taxes slowing down the growth engine and falling on the shoulders of small business owners with pass-through taxation, etc. We’ll know about these changes sometime during 2010.
Based on my math and what I’ve been hearing at seminars on the Roth conversion, the people that will benefit most are those that can afford to pay the conversion tax out of their own pockets and NOT from the account they are converting. If you were to pay the money out of the account you’re converting—and tax rates didn’t change—you’d be doing nothing but giving the government a gift of up-front taxes. By paying it out of pocket you are effectively adding more money into your Roth IRA which works out nicely in an environment in which tax rates increase and stay increased for the next 10 years or so. Further, if your tax bracket will drop when you retire (because you’re earnings less money) the Roth conversion also becomes a bit less attractive, bringing me back to the point that the government is looking more at high-earners and people with assets into the millions to prioritize doing these conversions.
If you’re under 59 ½ and paying a penalty by taking money out of your IRA to pay the conversion tax, you’re really not doing yourself any favors at all.
The way the rules read, if you do the conversion in 2010, you will pay ½ the conversion tax by April, 2011 (2010 tax return) and the other ½ by April, 2012 (2011 tax return). You can pay it all during 2010 but why give the government your money early? The only reason might be that during 2011 the highest marginal tax rates jump as we discussed above. Then the math becomes what you’re doing with that extra money in the 12 months between 2010 and 2011.
On another note, Congress has been allowing people not to take RMDs (required minimum distributions) during 2009 because it would be counterproductive to force people to take money out of their IRAs with the stock market at such low levels. With the stock market at higher levels now I find it unlikely they will extend waiving RMDs for 2010 and 2011 but who knows. If they do extend it, traditional IRAs become a bit more tolerable.
As far as I know, there is no age cap on who can do the conversion. Someone 62 or 82 can do it. There is also no income cap on doing the conversion. You can earn $80,000 or $800,000 and still convert. You can also convert directly from a traditional 401k or 403b into a Roth IRA without stopping into a traditional IRA first.
Also interesting is a piece I read this month by Darren Neuschwander, a CPA in Robertsdale, Alabama. Neuschwander notes that clients can choose to re-characterize BACK to a traditional IRA anytime until they file their tax return in 2011—which can be April 15th or October 15th if an extension is filed. Neuschwander notes that any client converting a decent amount of money during early 2010 should do a tax extension and carefully analyze the markets and incoming tax information so they can switch back to a traditional IRA if that math ultimately works better.
As always feel free to e-mail me with any questions. I’m not a CPA so any further details may best be answered by your tax professional.
Russell Bailyn
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Wealth Manager
Premier Financial Advisors, Inc.
14 E 60th St. #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673
rbailyn@premieradvisors.net
Investors should consult their tax professional or financial advisor for more information regarding their specific tax situations.
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.