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New Rules on Roths

Article

In 2010, upper-income taxpayers will, for the first time, be able to convert their traditional IRAs to a Roth IRA and reap the Roth’s tax advantages. Financial advisors caution, however, that you should convert only if you can afford to pay any taxes incurred from current income.

Next year could be a watershed year on many financial fronts. The estate tax is scheduled to disappear, it may be the last year for the Bush-administration tax cuts, and, for the first time, upper-income taxpayers will be able to convert their traditional IRAs to a Roth IRA and reap the Roth’s tax advantages. Up until now, taxpayers with an Adjusted Gross Income of more than $100,000 have been barred from making the conversion. The more lenient conversion rules will be in effect just for 2010 and will apply to all taxpayers, whatever their income is.

If your traditional IRA was funded with pre-tax money, you’ll have to pay federal income tax on the assets you convert, but you can lessen the tax burden by splitting the amount of the conversion, reporting half on your 2011 tax return and the rest on your 2012 return. If your IRA is funded with after-tax dollars, on the other hand, you’ll pay taxes only on the earnings, not on the contributions you’ve made. Many financial advisors suggest, however, that you convert only if you can afford to pay any tax from current income, rather than tapping the assets in the IRA to settle the tax bill.

The big advantage with a Roth IRA is that withdrawals are tax-free. Another plus is that, unlike a traditional IRA, there are no mandatory distributions - you can leave the money in the Roth IRA for as long as you want. When you die, your spouse automatically becomes the owner of the Roth and won’t be required to take withdrawals. If it’s passed on to your children, they will have to take out money every year, based on their life expectancy, but they won’t have to pay taxes on it.

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Victor J. Dzau, MD, gives expert advice
Victor J. Dzau, MD, gives expert advice