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Money held in a Roth IRA can be withdrawn tax-free. Money held in and withdrawn from other types of retirement accounts (regular IRA, SEP, 401(k), etc.) is taxed at ordinary income rates at the time of withdrawal.
Think about it. Income without taxation. How wonderful life would be!
Consider as well that, odds are, your income will be higher when you're older. You'll be in a high tax bracket. I'd also bet that tax rates will be higher then, because our federal government is going to have to find ways to increase its take. After all, it's going to have to pay back the trillions of dollars of debt now being carried. So getting some of your wealth into a Roth IRA account is a hedge against potentially high future tax rates.
The problem is, under current tax law, only persons earning less than $116,000 ($169,000 if married filing jointly) can contribute to a Roth IRA. That's been blocking you and me from the Roth. But, lo and behold, this bad economy has done a number on your income. My income. So maybe you qualified in 2008? Maybe you will in 2009?
Convert Current Retirement Accounts to a Roth
Annual Roth IRA contribution limits are just $5,000, in most cases. Over time, and with appreciation (tax-free, I might add), your Roth balances will grow, but the big ticket would be if you could convert an existing retirement account into a Roth.
Good news. This can be done.
Only those earning less than $100,000 can do this, but maybe you qualify now (2008)? Maybe you will in 2009? If not, no need to worry, the limitation goes away entirely in 2010 (under current tax law).
Of course, there's no free lunch. Converting a traditional retirement account to a Roth requires that you pay ordinary income tax rates on the amount you move to the Roth. Painful, to be sure, but consider the following:
- Once your money is in a Roth it will grow tax-free and can be withdrawn tax-free.
- There are no withdrawal requirements as with a traditional IRA.
- Your Roth IRA can be passed to your heirs, tax-free, who also may withdraw monies from it tax-free.
- Having some monies in a Roth is, as we said above, a nice bit of diversification. That is, a little hedge against the risk that future income tax rates could be very high.
- To the extent that your income took a hit in 2008, or will in 2009, the rate that your converted balance is taxed at will be lower (i.e., a lower tax bracket).
- Due to the recent sharp decline in the value of most investment types, it's likely that the total value of the money held in your retirement accounts is depressed, which will result in a lower tax bill upon transfer (i.e., it's the perfect time to convert to a Roth).
To be sure, the rules on qualification and conversion are complex. Go figure. Talk to your tax advisor.
This article originally appeared in The Business Owner Journal, the periodical of choice for owners of small and midsize private businesses. All rights reserved, D.L. Perkins LLC. © 2010.
This publication is intended to provide general information on the subject matters covered. It is sold and distributed with the understanding that neither the publisher nor any distributor or advertiser is engaged in providing legal, tax, insurance, investment or other professional advice. The advice of a qualified professional should be sought before any reader applies a concept presented herein to his or her particular situation or business.
D.L. Perkins, LLC is solely responsible for this content.
