As we near the end of 2010, a lot of people have already accomplished Roth IRA conversions, and plenty of others are questioning if a Roth IRA conversion in 2010 is the right move for them.
Why are Roth IRAs in the news a lot this year? Previously, Roth IRA conversions were limited to individuals who earned under a certain income limit ($100,000). A change in the guidelines, effective as of January 2010, removes the income limit which means much more individuals are allowed to to convert from traditional IRAs to Roth IRAs.
A part of this new rule is the ability to pay the taxes from any conversions carried out in 2010 over 2 years. Instead of having to pay out the taxes from the conversion all on one tax return, the IRS is permitting you to pay off half in 2011 and half in 2012.
Though the new regulations might appear too good to pass up, you ought to check out the situation very carefully before jumping right into a Roth conversion in 2010. Just because you could convert to a Roth doesn't mean you should do a conversion, at the very least not right away.
Before you make a decision on whether to convert or not, listed below are some fundamentals about traditional and Roth IRAs you ought to be well aware of:
Traditional IRAs
- Money put into traditional IRAs is actually tax deductible (income limits apply if you are covered by an employer sponsored retirement plan)
- Withdrawals coming from traditional IRAs are taxed at your ordinary income tax rate, so in case you are in the 15% tax bracket you will pay off 15% on the amount withdrawn, if you're within the 28% tax bracket you'll pay 28% on any distributions, et cetera.
- The IRS requires you to take a minimum amount out (based on your age and the account balance) after age seventy 1/2.
Roth IRAs
- Contributions to a Roth IRA are not tax deductible.
- You might not be allowed to contribute to a Roth IRA when your income is above the limits.
- Qualified withdrawals (should be at least age 59 1/2 and have had the Roth for at least 5 years) are not subject to income tax.
- In contrast to traditional IRAs, you are not required to take cash out of your Roth IRA when you reach age 70 1/2
Should You Do a Roth Conversion?
You should think about converting to a Roth IRA if:
- You expect to be in the same or higher tax bracket after you retire (or when you will need the funds),
- You will not need the money you convert for 5 years or more, and
- You could afford to pay the taxes on the conversion without dipping into your very own retirement savings.
It's important to note that just because you could convert to a Roth IRA doesn't mean you need to convert to one. You should check with a financial or tax expert to determine if a Roth IRA conversion is best for you, since every situation is different. A Roth conversion in 2010 may not make sense for you, but a conversion in future years could make sense if tax laws change or your own situation changes.
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