2010 has leveled the playing field for Roth IRAs; the federal government has eliminated the income limit for converting a traditional IRA to a Roth IRA. This will benefit millions of Americans making $100,000 or more whom were previously unable to take advantage of a Roth IRA or convert their traditional IRAs into a Roth. The new law repeals previous income limits for conversions; however, income limits still apply to Roth IRA contributions.
We must always think of Uncle Sam since he, too, benefits from the taxes that will be collected on capital gains that were accrued pre-conversion.
What’s the difference?
Those whom are younger than 50 years of age can contribute up to $5,000 annually to an IRA. NB: If an individual is older than 50 years of age, they can contribute and additional $1,000 in retirement catch up, totaling $6,000 annually.
There is no mandatory age at which someone must stop contributing to a Roth, compared to 70 ½ with a traditional IRA. If an 80-year-old grandmother wants to open a Roth IRA, she can do so.
Any income earned on a Roth IRA is tax-free when a consumer withdraws after age 59 ½ as long as it has been five years since the Roth’s inception; however, all withdrawals from a traditional IRA are taxable as ordinary income.
Tax you very much!
The rules for IRA conversion taxation have changed slightly for 2010: and 2010 only! This year, anyone who converts a traditional IRA to a Roth IRA will have the option to spread out his or her tax bill, 50/50, over the 2010 and 2011 tax year. But, be aware that taxes will be on the rise next year because of the sunset provision in the tax act of 2001 – however, this may be overturned with new legislation as this year progresses. Be cognizant of your tax burden and decide accordingly.
Keep in mind; after a certain income level, the IRS prohibits traditional IRA contribution tax deductions.
For those of you that are making more than $120,000 (ineligible to contribute to a Roth IRA), open a traditional IRA and max out your annual contributions, then convert to a Roth immediately. This way, you can take advantage of tax-free growth even if you are ineligible to contribute to a Roth IRA.
Froth Your Roth:
Do not just put your money into a Roth and leave it to rot, take full advantage of the fact you have the ability to grow your money TAX FREE. Trade stocks/options within the account and grow it to the hilt! Many people, well, those of whom actually save, just put their money in these accounts and expect them to grow magically. Not going to happen… be smart.
Fidelity has a great calculator to see if converting is in your best interest: Here
As always, speak with your accountant before making any final decisions.