Next year will bring big changes to Roth IRA rules
October 26, 2009, 9:30AM
Since its creation more than a decade ago, the Roth IRA has been one of the best tax breaks around, but it’s been closed off to higher-earning taxpayers.
That will change next year.
Starting in 2010, the rules governing the conversion of a traditional IRA into a Roth IRA will allow anyone — regardless of income — to switch their existing retirement savings account.
The change in 2010 "has the potential to be a fairly big deal," said Rande Spiegelman, vice president of financial planning at the Charles Schwab Center for Financial Research.
Depending on your financial circumstances, converting your traditional IRA to a Roth IRA might be a smart move, but consumers should do their homework first.
"Look before you leap," Spiegelman said. "Just because you can do it doesn’t necessarily mean you should." The benefits of a Roth IRA are substantial. Here’s why:
- Contributions to a Roth aren’t tax-deductible, but earnings can be withdrawn tax-free if you’re at least 59½ years old and have had the Roth for at least five years.
- There’s no mandatory distribution age as there is with a traditional IRA, which means if you don’t need the money, you can leave it in the Roth to continue growing.
In a traditional IRA, contributions are tax-deductible and taxes are paid when earnings are withdrawn. Withdrawals can begin at age 59½ and are mandatory by age 70½ because Uncle Sam wants the income taxes due him.
Despite the benefits, the decision to convert your IRA shouldn’t be automatic.
As a general rule, tax planners advise against paying a tax today that you can defer until a later date. But there are always exceptions, and converting to a Roth IRA now may well be one of them.
When you move from a traditional IRA to a Roth IRA, you pay income tax on the amount converted.
But for 2010 only, you can spread the income over two years.
So if you converted a $100,000 traditional IRA in 2010, you could report $50,000 in ordinary income in 2011 and $50,000 in 2012.
"The tax hit is real and it’s permanent," Spiegelman said.
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