Soon everyone will be able to enjoy the tax-free benefits of a Roth IRA, regardless of annual income. Historically, the Roth IRA has had strict eligibility requirements based on income levels, which limited investor participation in this valuable retirement savings vehicle. With the new Roth conversion provisions, that’s all set to change.
Beginning in 2010, the $100,000 modified adjusted gross-income ceiling will be eliminated for conversions from a traditional IRA (and some employer retirement plans) to a Roth IRA.
Review Your Strategy
Like a traditional IRA, the Roth IRA offers tax-deferred growth, plus these additional retirement benefits:
> No required minimum distributions (RMDs) for account holders, and potentially for spousal beneficiaries
> The ability to contribute past age 70 and a half for individuals with earned income
> Qualified tax-free distributions
Contribute to your traditional IRA today
Remember, there are no income eligibility limits for non- deductible contributions to traditional IRAs. Anyone under age of 70 and a half with earned income can contribute up to $5,000 for 2009. Investors age 50 or older can make an additional annual $1,000 in catch-up contributions. You can then convert your traditional IRA to a Roth IRA starting in 2010.
Stretch Tax Liability Across Two Years
You will have to pay income tax on the taxable portion of the assets you convert to a Roth IRA. However, for amounts converted to a Roth IRA in 2010, tax liability can be stretched across the next two tax years by paying 50 percent in the 2011 tax year and 50 percent in the 2012 tax year. Check with your tax advisor for additional details on whether the conversion strategy makes sense for you.
Important Pro-Rata Rule
If you convert from a traditional IRA, Sep-IRA, Simple IRA or rollover IRA that contains both pre-tax and after-tax assets, you should be aware of the pro-rata rule. The taxable portion of your conversion will be determined by the ratio of the pre-tax earnings to the after-tax contributions.
For example, let’s say your IRA is worth $400,000:
> $360,000 (90 percent) in pre-tax assets
> $40,000 (10 percent) in after-tax assets
If you convert 25 percent, or $100,000 of the total amount to a Roth IRA, the conversion amount will be taxed as follows:
> $90,000 (90 percent) converts and is taxed
> $10,000 (10 percent) converts tax-free
If you have multiple IRA accounts (traditional IRA, Sep-IRA, Simple IRA or rollover IRA), this ratio will be based on the combined pre-tax and after-tax assets from all of your IRAs.
Here’s How The Roth Conversion Strategy Works:
> Before the Roth Conversion – Beginning in 2007, Tom, age 35, began funding a traditional IRA with non-deductible after-tax contributions. He contributed $4,000 in 2007, then $5,000 in each of the following three years: 2008, 2009 and 2010, for a total of $19,000. By 2010, tom’s IRA grows to $23,000 ($4,000 in gains).
> Tax Treatment At Conversion – Tom converts the traditional IRA in to a Roth IRA in 2010. He owes no taxes on the $19,000 in contributions because they were made with after-tax dollars. He owes $1,320 in income tax on the $4,000 gain. Tom can split the $1,320 tax bill on the $4,000 in gains over the next two years.
> After the Roth Conversion – After Tom converts the $23,000 to a Roth IRA, it continues to grow tax-free. If tom keeps the money in the Roth IRA for 20 years and earns an 8 percent annual growth rate, the assets could grow to $107,000. He will owe no taxes on the distributions. Also, there are no required minimum distributions (RMDs).
To Convert or Not? Some Factors to Consider:
> If you convert to a Roth IRA, you will need to pay taxes on the taxable portion of the conversion amount.
> If you’re not ready to convert in 2010, you can sill convert to a Roth at a later time. Or, you may decide that converting only a portion of your assets is best for your situation.
> If you expect to be in a higher income tax bracket in retirement, converting to a Roth IRA now may help offset your tax burden later.
> The more time you have until retirement, the greater potential for tax-free growth from a Roth IRA.
> Your employer-sponsored retirement plan may also be eligible for conversion.
Is A Conversion Right For You?
Contact your financial advisor today to discuss the Roth conversion. Together, you can evaluate whether a Roth conversion makes sense as part of your overall financial plan.
As a firm providing wealth management services to clients in the U.S., we offer both investment advisory programs and brokerage accounts. Advisory services and brokerage services are separate and distinct, differ in material ways and are governed by different laws and separate contracts. For more information, please visit our website at www.ubs.com/workingwithus
This article has been written and provided by UBS Financial Services Inc. for use by its financial advisors.
Neither UBS financial services Inc. nor its employees provide legal or tax advice. You must consult with your tax and/or legal advisors regarding your personal circumstances.
