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Roth Conversion 2010


Put your money in a 401K and get a tax break now. Then, let the money accrue tax free and pay taxes later. Alternatively, switch that 401K to a Roth IRA this year, pay the taxes and let the money grow tax free and take it out tax free.

Think of this scenario. You are 85, still in your own home, and you enjoy activities. Your health is good for your age, but the income that you’ve relied upon isn’t so generous anymore. You’re beginning to run out of money.

This frightening situation could happen to anyone; in fact, it is an older person’s worst nightmare. But now there is an option that could lessen this problem for selected individuals. It is the Roth IRA conversion, available this year for those of any income level, not just individuals with specific salaries that hover around $100,000.

By shifting to a Roth IRA and paying taxes now, tax free income later is guaranteed when the funds are dispersed, and that can start anytime after 59 1/2 provided the Roth has been in existence five years. Dispersement does not have to begin at 71 1/2 as it does with regular IRA distributions and, additionally, since taxes are increasing, not paying them on the distributions of a Roth IRA seems like an appealing option.

Still, it is best not to jump to conclusions.

One way to judge if this is right for you is to discuss it with your accountant who may have financial software that can help determine whether or not the tactic fits your specific situation. Alternatively, If you have a financial advisor, check it out with him. Also, there are websites that give direction too, so a pre-professional look is possible.

Among these are Ameritrade, which offers IRA conversion analysis under retirement planning. The Ameritrade option requires that you be a client. My own opinion is that the results of the analysis may be too complicated for some customers although a tutorial is available.

State Farm Insurance, on the other hand, has calculations open to everyone. It is easy to use and analyzes the tax due if a conversion is made; this is a rather sobering experience because the immediate taxes can be high. The latter may be enough to stop some from going forward because coming up with the tax money may not be an easy task.

Also, once converted, the Roth IRA owner has to live long enough so that the tax advantage of withdrawing funds tax free outweighs the taxes that were paid upon conversion. This is because this tax money could have been invested.

For example, a 50 year old who plans to retire at 60, with 500K in an IRA could save $93,801 by converting to a Roth IRA now according to the State Farm analysis using these assumptions:

Assumed Rate of Return: 5%

Current Federal Income Tax Rate: 28%

Future Federal Income Tax Rate: 36%

Withdrawal begins: age 60

Alternatively, making the conversion at an older age and retiring five years later is less advantageous because the Roth funds have fewer years to accrue in value unless the owner of the Roth chooses to delay taking out the funds.

One choice that could be appealing to many is to convert only some eligible funds. Then they could be used last as an ‘insurance policy,’ should one or both spouses live to a ripe old age.

In summary, anyone can convert to a Roth this year. That is the good news. But whether or not this might be beneficial for a particular person depends on the following:

  1. Ready money to pay the taxes due in 2010 (see State Farm Insurance analysis; it provides taxes due).
  2. Tax bracket in retirement - the higher, the more likely the conversion would benefit.
  3. Age: the younger the better. If the Roth IRA conversion participant is older, the chance of living to utilize its advantages may not offset the immediate payment of taxes.

Lastly, see a professional who can crunch your specific numbers, and give concrete information. Guesswork is not an option here. Your life could literally depend on it.

This information and content is offered for informative and educational purposes only. MyMoneyMD, LLC is not acting as a Registered Investment Advisor, Investment Counsel, Tax Advisor, or Legal Advisor.

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Victor J. Dzau, MD, gives expert advice
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