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Wealth Management
Insights
For higher-income investors, a new opportunity to
convert retirement savings to a Roth IRA is right
around the corner. Is this the right move
for you?
The law restricting higher-income investors
from converting their Traditional IRA's to Roth
IRA's will be removed in January. This means
that, for the first time, individuals or joint
filers making more than $100,000 per year can take
advantage of the benefits of a Roth IRA, including
the ability to pay taxes on balances at their
current tax rates versus the potentially higher
rates later and no minimum distribution
requirements. Also, a special provision will
let investors spread out the tax impact of a 2010
conversion over 2011 and 2012. But before
you rush to convert your retirement savings to a
Roth, you need to determine if it's the right
strategy for you.
The longer you can leave money in a Roth IRA
after conversion, the more effective the strategy
will be.
What You Should Know:
1. A Roth conversion isn't for everyone
A Roth IRA can be an incredibly useful savings
tool for the right investors, but the ultimate
value of the Roth conversion strategy depends
largely on when you plan to use the money in the
account. In general, the longer you can
leave money in a Roth IRA after conversion, the
more effective the strategy will be. If you
convert your IRA in one year and then start
withdrawals shortly afterwards, the assets won't
have grown enough to offset the upfront income
tax. Paying taxes upfront only makes sense
if the Roth can grow long enough, on a tax-free
basis, to compensate. Because of this, there
are two groups that typically benefit the most
from a Roth conversion:
* Those who don't plan to ever use the assets in
the IRA because they have enough other retirement
assets (ie: taxable savings, Social Security,
pensions, etc.) to support their lifestyles.
For this group, a Roth conversion is like making a
gift to their heirs equal to the taxes on the
account.
* Younger individuals who can't access the
account for many years. In order for Roth
IRA withdrawals to be tax-free, the earnings have
to be in the account for at least five years.
In addition, the owner must be at least age 59
1/2, or meet one of several other requirements
(such as death or disability.) These
restrictions make Roth IRA's better suited as a
long-term savings tool.
2. Think about your future
If you expect to be subject to a higher tax
rate in retirement than you are today, a Roth
conversion may be appropriate. Even though a
Roth conversion requires you to pay taxes today
that could have been deferred, it could ultimately
end up costing you less if you expect to be in a
higher tax bracket in the future.
3. Timing is everything
While a Roth conversion is often a better idea
for younger investors with higher future earning
potential than it might be for more established
professionals nearing retirement age, Roth IRA
owners are not forced to take Required Minimum
Distributions (RMD) at age 70 1/2. This
feature can be quite appealing to older
high-net-worth investors, especially for those who
wouldn't withdraw from their IRA's if not for RMD
rules. The owner's heirs will be required to
take minimum distributions, just like they would
from a Traditional IRA, but those withdrawals will
be tax-free.
4. It doesn't have to be all-or-nothing
Even if an in-depth evaluation of your current
financial situation and long-term goals indicates
a Roth conversion might make sense for you today,
there are factors playing out in real time that
could change the bigger picture in the near
future. For instance, it's very possible
that taxes will increase for those in the highest
bracket after 2010. And, if the federal
deficit continues to increase as it has recently,
the need to raise taxes more aggressively in the
future may well become more urgent. For
these and other reasons, you may want to diversify
your retirement assets across tax-deferred and
tax-free investment vehicles. You aren't
required to convert your entire Traditional IRA to
a Roth IRA. Any amount you do convert should
create a manageable tax liability today and should
consist of assets you won't need to access for a
number of years, but the rest can stay put.
What Should You Do Now:
Converting your retirement savings to a Roth
IRA could be a very beneficial or unexpectedly
costly decision if made hastily. It's
important to carefully consider the implications
of a Roth conversion in the context of your
complete financial picture and comprehensive
long-term plans. Beware of most
do-it-yourself, online Roth IRA conversion
calculators. These often make standard
assumptions about goals and time horizons, which
can actually vary widely to different individuals.
We strongly recommend that you get help from a
Financial Advisor who truly understands and
accounts for the intricacies of your unique
situation in a comprehensive financial plan that
looks at your future using either a Traditional or
a Roth IRA, or both.
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