The allure of Roth IRAs is that distributions made out of a Roth IRA are never taxed. In effect, taxpayers become immune to future tax increases enacted by Congress. Roth IRA owners, thus have an effective tax rate on Roth IRA distributions equal to 0%, forever. The ability to contribute to a Roth IRA has always been limited if an individual taxpayer's adjusted gross income exceeds a specified amount, adjusted for inflation. Thus, wealthy taxpayers, without any other retirement plan, had to rely on making traditional IRA contributions, which impose no such income test. The upside for traditional IRAs is that contributions are tax deductible. The downside is that future distributions are subject to income tax at the rate in effect when the distribution is made.
Given the immense size of the federal deficit, almost every tax professional has been advising their tax clients that tax rates must go up in order to increase tax revenues to meet the future cost of government. In order to immunize their tax clients from the cost of future tax increases, tax professionals were advising their clients to convert as much of their traditional IRAs as possible. Some taxpayers were eligible to convert their traditional IRAs into Roth IRAs and pay the requisite tax on the accumulated earnings. However, many higher income taxpayers were unable to make the conversion due to an income limitation known as the $100,000 limitation. The $100,000 limitation prohibits taxpayers from converting their traditional IRAs into Roth IRAs if their adjusted gross income exceeds $100,000 in the year of conversion. So for many years, due to these two Roth IRA income limitations, wealthy individuals have been forced into making contributions to traditional IRAs in lieu of Roth IRAs, and were prohibited from converting their traditional IRAs into Roth IRAs.
But that is all about to change. Effective January 1, 2010, the $100,000 limitation is going away forever. Furthermore, any taxpayers who convert their traditional IRAs on January 1, 2010 to Roth IRAs will be able to defer the requisite tax on the accumulated earnings over two years beginning with tax year 2011. If a taxpayer converts a traditional IRA to a Roth IRA in 2010, he or she may elect to spread the tax hit over 2011 and 2012, with no tax payment required in 2010.
Call your tax professional today if you have traditional IRAs to evaluate if conversion to a Roth IRA is right for you.
Tom is a Certified Public Accountant, a Certified Financial Planner, CLTC (Certified Long-Term Care) and President of Cerefice & Company, the largest CPA firm in Rahway, New Jersey. Tom works with clients helping them manage their money, retirement planning, college savings, life insurance needs, IRAs and qualified plan rollovers with an eye towards maximizing tax benefits and minimizing taxes. Tom is founder of the Rich Habits Institute and author of "Rich Habits".
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