Thinking about starting a Roth IRA? Now is the right time
By Brent A. Lindell
Today’s down market may have you sitting still and holding on to your money, but there is one move that you should investigate taking advantage of in 2009 — now is a better time than ever to convert a traditional IRA to a Roth IRA, which has a wealth of tax benefits for investors.
What’s the difference?
Just to review the basics, a traditional IRA is an individual retirement account held at an institute such as a bank or brokerage. The only requirement to contribute to an IRA is sufficient earned income to invest, but withdrawals are subject to federal income tax.
A Roth IRA is an individual retirement arrangement in which you place after-tax money. Your investment grows tax-free and the withdrawals are also tax-free when the requirements are met.
Why is now a good time to convert?
Given that the performance of the market is off more than 50 percent from its 2007 highs, if your IRAs were invested in the market, the values are probably quite a bit lower than they were previously. Therefore, it will cost an individual less than any other past year to convert a traditional IRA to a Roth IRA. If you don’t plan to retire soon, this is an even better opportunity.
New in 2009 – investors are able to fund a Roth IRA with distributions from a traditional IRA. This is the first time individuals have been able to convert a Required Minimum Distribution (RMD) from a traditional IRA to a Roth IRA. In previous years, individuals were only allowed to convert excess amounts over their RMD. But because of today’s economic situation, the federal government is allowing investors to keep their money in their IRAs and not force them to take a distribution. Because of this rule suspension, any withdrawals from a traditional IRA can be used to fund a Roth IRA.
What are the pros of converting to a Roth IRA?
Besides the tax-free withdrawals, Roth IRAs have many other benefits. For one, they do not require a mandatory distribution. Second, an individual can still contribute to a Roth IRA after the age of 70½. This is very good news for retirees who have other sources of income in retirement and aren’t ready to take money out of their IRAs quite yet. This also means they are easy to pass down to heirs, so individuals can feel good about leaving something for their loved ones after they pass away. Converting a traditional IRA to a Roth IRA can also lower your taxable estate.
What’s the catch?
Let’s get the fine print out of the way now: You will have to pay a one-time tax on the conversion. The cost of making the move is the current income tax on the conversion. But because of the market being at such a low point, your IRA is probably at its lowest point, meaning you are going to be taxed less when you convert.
The other catch: Until 2010, individuals with a modified adjusted gross income of $100,000 or LESS are allowed to make the conversion. A married person filing a separate return is also ineligible for a conversion.
So while your IRA may be showing lower numbers today than it has in the past, that can also mean that it will cost you less to switch over and begin receiving better tax benefits for retirement.
