Friday, May 7, 2010

2010 Window Open for Roth IRA Conversions

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

In 2010, anyone, regardless of income level, may open or transfer funds from an IRA account to a Roth IRA, thanks to the Pension Protection Act of 2006.

Prior to this year, only taxpayers with an Adjusted Gross Income of $100,000 or less have been allowed to convert funds from their (individual retirement account)  IRA into a Roth IRA. With a Roth IRA, all contributions are after-tax (i.e. non-deductible), however, earnings from the account can be withdrawn free of federal income taxes once the individual reaches retirement.

Earnings from assets transferred from an IRA account, are not available for tax free withdrawal until five years have passed since conversion and the account holder is at least 59½ years old. There are no minimum distribution requirements for a Roth IRA.

To convert existing IRA funds to a Roth IRA, taxes must be paid on any pre-tax IRA contributions, but there's another benefit to converting in 2010. For funds converted in 2010, the tax liability can be paid one half in tax year 2011 and half in tax year 2012. Convert in 2011, and taxes will be due on the full conversion amount for tax year 2011.

Before you opt to convert to a Roth, however, you need to run the numbers. Although all earnings from a Roth IRA are exempt from federal income taxes, by paying taxes on all contributions in advance you lose the earning power of those funds. You may also be paying taxes at a higher rate than you might if you held your IRA into retirement when your tax rate might be less.

Typically, a Roth conversion will make the most sense for individuals with years to go before they retire. The closer you are to retirement, the less value a Roth might have unless your goal is to pass on the IRA to your heirs.

There are no distributions required from a Roth IRA during your lifetime and by converting to a Roth and paying the necessary taxes, you will shrink your taxable estate. That could mean bequeathing a pool of income-tax-free money to your heirs.If you have an IRA in which after-tax contributions have been made, you only need to pay taxes on accumulated earnings to convert to a Roth IRA.

As always, please consult your tax and/or financial advisor before making any irreversible decisions!

Please feel free to email me with any questions or comments at

Until next time…

Paul Schatz

Heritage Capital LLC

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