To Roth Or Not To Roth

A tax tsunami is coming at the end of this year. And this is the absolutely last chance for a massive Roth conversion.

As you likely have read, the end of 2012 and the transition to 2013 are likely to be a tumultuous time for taxes of all sorts. Accordingly, this is a year of planning.

One major thing to bear in mind: This may be the last excellent year for the Roth IRA conversion.

Forbes recently ran a few articles on this subject, including this recent test. I thought I’d share it here to help you determine whether a Roth IRA conversion may be right for you. So, somewhat abridged, here it is:

1. Do you expect your tax bill to stay the same well into retirement?
2. Do you have a traditional IRA (especially a large one) that can be converted?
3. Are you ready, willing, and able to pay for the taxes of tomorrow, today?
4. Are you interested in estate-reduction and, at once, leaving a large tax-free gift to your heirs?

If you answered “yes” to the above questions, then you may want to put pencil to paper and assess whether a Roth IRA can make sense and, more to the point, can create a huge savings now and a huge value for your heirs later.

The big payoff: A Roth IRA is not a tax-deferred account as retirement accounts traditionally are. The reason a tax-deferred account is nice is that it’s assumed you’ll have a lower income in retirement and, therefore, have a lower tax percentage. As a result, you allow the account to appreciate now and ultimately pay fewer taxes later.

If your income is not expected to drop, as is often the case, then your tax bracket might not drop and so your tax savings won’t appear. Instead, you’ll have less liquidity during the golden years.

By paying the taxes upfront, by rolling a traditional IRA into a Roth, you’ll pay a tax upfront to secure that account for the future and avoid any RMD’s (the very same that might force you into other tax problems).

Moreover, since taxes are generally expected to go up with the expiration of the Bush-era tax cuts (unless some serious attention is given) paying the tax now might be an actual steal.

There is more information in the original article on this subject.

Reference: Forbes (February 20, 2012) “Roth IRS Conversion 2012: Are You A Good Candidate?”

Comments

[Basudev]

If a taxpayer trnveocs his or her IRA and then dies, the amount of conversion income not previously reported, will be included in the decedent's final tax return. However an exception is made if the Roth IRA is inherited by the spouse. If the spouse so elects, the spouse can continue to report the conversion income on the same schedule as the decedent would have. This election cannot be made or rescinded after the due date of the spouse's tax return for the year of the decedent's death. Roth IRA Conversion AdvantagesThe 2010 Roth IRA conversion may prove beneficial for a number of investors. Assuming tax rates do not drop significantly in the future, the conversion makes a lot of sense. The main advantage of the Roth IRA is its very favorable tax treatment when it comes to distributions. These qualified distributions are tax free, of course, but there are some other Roth IRA conversion benefits:There is no Required Minimum Distribution (RMD) during your lifetime.An IRA conversion to Roth IRA will require the payment of any necessary taxes, but will assist in shrinking your taxable estate. This provides you the opportunity to bequeath the select Roth funds tax free to your heirs.You can choose to not pay taxes on the conversion in 2010 and postpone the taxes in equal shares until 2011 and 2012. Normally, you'd be required to pay all taxes in the year of the conversion.Obviously, the primary advantage of the Roth IRA is its tax-free nature. Having investment earnings completely free from taxation is alluring, but the two following Roth IRA rules must be met in order to receive tax-free distributions:1. The withdrawal takes place at least five years after the initial Roth contribution, and2. One of the following applies:a. The Roth IRA owner is 59 bd or olderb. Disability (permanent)c. Death of participantd. First-time home purchase ($10,000 lifetime cap)

[Emin]

It sounds like you're tanilkg about taking distributions from your retirement accounts taking money out after you've reached retirement age. 401K distributions (and traditional IRA distributions) are taxable income, since you didn't pay taxes on the money when you put it in. Roth IRA distributions are not taxable, since you already paid tax on that money before you put it in.If you're tanilkg about putting money into your accounts, remember that the 401K is pre-tax and the Roth is after tax. (Separate yearly limits apply to each.) Don't put the wrong kind of money in either account, it will cause tax headaches later.