Is a Roth IRA Conversion Right for You?
by Ana L Barnett, LPL Financial Advisor

Until recently, retirement investors who wanted to convert all or a portion of their traditional IRA account balance to a Roth IRA faced a stumbling block: According to old IRS rules, conversions were available only to those with modified adjusted gross incomes (MAGIs) of $100,000 or less. But in 2010, this restriction was removed, permitting retirement investors at any level of income to convert assets from a traditional IRA to a Roth IRA.

Let’s explore some of the factors that may affect your decision to convert assets within a traditional IRA to a Roth IRA as well as the potential benefits and tax implications of a conversion.

Whether you should convert all or a portion of your traditional IRA assets to a Roth account may depend on the amount of time you plan to leave the assets invested, your estate planning strategies and your willingness to pay the federal income tax bill that a conversion is likely to trigger.

Two Types of IRAs: Traditional & Roth
Each type of IRA has its own specific rules and potential benefits. These differences are summarized below.

Traditional IRA
Maximum Annual Contribution
$5,000 for single taxpayers and $10,000 for couples filing jointly for 2011. An additional $1,000 “catch up” contribution is permitted for each investor aged 50 and older who has already made the maximum annual contribution.

Income Thresholds for Annual Contributions
None, as long as the account holder has taxable compensation and is younger than age 70½ by the end of the year.

Deductibility of Contribution
Yes, if account holder meets income requirements established by the IRS.

Contributions After Age 70½
No contributions allowed after age 70½.

Required Minimum Distributions (RMDs) After Age 70½
RMDs are required.

Taxes on Distributions
Qualified distributions are taxed as ordinary income. Withdrawals before age 59½ may also be subject to a 10% penalty.1
 
Roth IRA
Maximum Annual Contribution
Same as Traditional IRA: $5,000 for single taxpayers and $10,000 for couples filing jointly for 2011. An additional $1,000 “catch up” contribution is permitted for each investor aged 50 and older who has already made the maximum annual contribution.

Income Thresholds for Annual Contributions
Single taxpayers with MAGI in excess of $122,000 and married couples filing jointly with MAGI in excess of $179,000 are not eligible in 2011. Income thresholds are indexed annually.

Deductibility of Contribution
No.

Contributions After Age 70½
Contributions allowed after age 70½ if owner has earned income.

Required Minimum Distributions (RMDs) After Age 70½
Not required at any age.

Taxes on Distributions
Qualified distributions are tax free. Withdrawals from accounts held less than five years or before age 59½ may be subject to taxes and a 10% penalty.1

Conversion: Potential Benefits …
Potential benefits of converting from a traditional IRA to a Roth IRA include:

• A larger sum to bequeath to heirs. Since RMDs are not required for Roth IRAs, investors who do not need to take withdrawals may leave the money invested as long as they choose, which may result in a larger balance for heirs. After an account owner’s death, beneficiaries are required to take distributions, although different rules apply to spouses and non-spouses.
• Tax-free withdrawals. Even if retirees need withdrawals for living expenses, withdrawals are tax free for those who are age 59½ or older and who have had the money invested for five years or more.

…As Well as a Potential Drawback
• Investors who convert proceeds from a traditional IRA to a Roth IRA are required to pay income taxes at the time of conversion on investment earnings and any contributions that qualified for a tax deduction. If you have a nondeductible traditional IRA (i.e., your contributions did not qualify for a tax deduction because your income was not within the parameters established by the IRS), investment earnings will be taxed but the amount of your contributions will not. The conversion will not trigger the 10% penalty for early withdrawals.

Which Is Right for You?
If you have a traditional IRA and are considering converting to a Roth IRA, here are a few factors to consider:

• A conversion may be more attractive the further you are from retirement. The longer your earnings can grow, the more time you have to compensate for the associated tax bill.
• Your current and future tax brackets will affect which IRA is best for you. If you expect to be in a lower tax bracket during retirement, sticking with a traditional IRA could be the best option because your RMDs during retirement will be taxed at a correspondingly lower rate than amounts converted today. On the other hand, if you anticipate being in a higher tax bracket, the ability to take tax-free distributions from a Roth IRA could be an attractive benefit.

There is no easy answer to the question “Should I convert my traditional IRA assets to a Roth IRA?” As with any major financial consideration, careful consultation with a professional is a good idea before you make your choice.

1IRA account holders (both traditional and Roth) may make qualified withdrawals before age 59½ only if they meet specific criteria established by the IRS (disability, qualified first-time home buyer and others). Consult www.irs.gov for additional information.

* This article was prepared by McGraw-Hill Financial Communications and is not intended to provide specific tax and investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions. If you have any tax-related questions, please consult a qualified tax advisor.

Ana L Barnett is a Financial Advisor with LPL Financial.  Ana specializes in the financial planning needs of individuals and families. Ana is registered to do securities business with residents of the following states:  DE, FL, NJ, NY, PA VA. 


Please visit Ana’s Web Page for more information and her archived articles:
http://www.womenofgloucestercounty.com/Business-Finance/Main-Street-Investment-Group.asp

If you have a question for Ana, you can contact her via email at ana.barnett@lpl.com.
Securities and financial planning are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.