New legislation taking effect in 2010 will leave many investors wondering if they should switch from a traditional IRA to a Roth IRA. A Roth IRA is different from a traditional IRA in that it is funded with after tax dollars. This gives rise to a number of considerations when setting up a Roth IRA conversion account. In many cases, these considerations can be complex and are best made with the help of an investment counselor or tax adviser.
First consider the question of taxes. If you move money from a traditional IRA to a Roth IRA conversion account, you will be required to pay taxes on the money coming out of the traditional IRA structure. Your investment counselor or tax adviser can help you determine how much those taxes will be. If you’re thinking about setting up a conversion account, you must consider whether or not you can afford those taxes at this time, as well as whether or not it’s worth it to perform the Roth IRA conversion. There may be a more advantageous time for you to pay those taxes.
However, if the final tax bill your expect to receive as a result of your Roth IRA conversion scares you, don’t worry. The new legislation described above offers you the opportunity to split up this tax burden over time in order to minimize your out-of-pocket expenses. According to the new Roth IRA rules, the taxes you owe on any conversions made in 2010 can be broken up over the next two tax years.
It’s also important to consider the timing of your proposed Roth IRA conversion. How long do you have before you anticipate beginning to make withdrawals? The longer your money remains in the conversion account, the greater the benefits of making the conversion, generally speaking. A minimum of five years is recommended by some financial counselors in order to make up the cost of the taxes you’ll owe. Otherwise, you may want to consider another type of IRA, rather than a Roth IRA conversion.
In some cases, though, one of the best reasons to establish a Roth IRA conversion account is – strangely enough – the opportunity to pay taxes on your money now. While most people anticipate being a lower tax bracket once they retire, that may not be the case for you. If you anticipate being in a higher tax bracket upon retirement, it makes sense to set up your rollover account and pay those taxes now. Or, if you plan to leave your savings to your beneficiaries or heirs, it may be advantageous to your estate to pay taxes now. Again, these considerations can be complex, and are best made with the advice of a financial professional.
When you’re setting up your Roth IRA conversion account, make sure you understand all of the tax implications involved in your transfer. If you’re ready to go ahead, your next step is to establish a Roth IRA with a provider who is well rated and provides excellent customer service. Make sure the Roth IRA is set up so that it can receive the funds before initiating the rollover request. T o minimize any potential tax liabilities, penalties and withholding, talk with your Roth IRA account manager or trustee about performing a direct rollover or trustee to trustee transfer when moving your funds into the account.