Financial Events

Click here for information about our upcoming client events and educational seminars.

The Virtus View is a weekly to bi-weekly e-mail publication that Brian authors in order to keep you updated on the current market situation.

ROTH Conversion

Starting this year, anyone can convert a Traditional IRA to a Roth IRA, including those with adjusted gross incomes of more than $100,000. This opens up the Roth IRA conversion window to people who were previously excluded … which is why you are all hearing so much about Roth Conversions now.

So … what is a Roth IRA conversion? A Roth IRA conversion is the term for moving funds from a Traditional IRA (pre-tax) to a Roth IRA (post-tax). Since, generally speaking, the funds are moving from pre-tax to post-tax, you have to pay taxes on the funds being moved.

But, let’s remember the key differences between a Traditional IRA and a Roth IRA. With a Traditional IRA, you contribute pre-tax money and it grows tax-deferred until you withdraw it. When take a withdrawal, you are taxed on your pre-tax contributions as well as the gains. You also have to start taking distributions at age 70 ½ whether you need the income or not … Uncle Sam wants his taxes! In contrast, with a Roth IRA, you contribute post-tax money and it grows tax-free … period. When you withdraw money from a Roth IRA, you don’t pay any taxes … not even on the gains and you don’t have to take distributions at 70 ½ unless you want to ...

Hence the dilemma … pay taxes on contributions now OR pay taxes on contributions and gains later?

It’s a tough decision. Here are just a few things to consider:

· Do you think your tax bracket is going to be higher when you retire?

If you believe that you will be in a higher tax bracket when you retire OR if you believe tax rates are going up, a Roth IRA Conversion may make sense for you. A Roth IRA conversion removes the dependency and uncertainty of future tax rates.

· When do you expect to start taking withdrawals?

If you don’t plan on taking withdrawals for the next 5 years OR don’t plan on taking withdrawals at age 70 ½, then a Roth IRA Conversion may make sense for you. The longer you plan on leaving the money in the Roth IRA, the more a conversion makes sense. Keep in mind that having to take required distributions from your IRA at 70 ½ may push you into a higher tax bracket … which takes us back up to question #1.

· Do you have a potential estate tax liability?

If you have a potential estate tax liability, converting to a Roth IRA may reduce that liability. If you die holding a regular IRA, the entire IRA may be included in your estate even though part of it will end up going to the IRS as income tax when your beneficiaries take distributions. In the case of a Roth IRA, you have already paid the income tax, so your estate is smaller even though you are effectively passing the same amount of wealth to your heirs.

· Can you pay the income tax with “outside funds” (non-qualified liquid assets)?

And this is the KICKER, if you can NOT pay to taxes from “outside funds” — meaning you have to use IRA money to pay taxes on the rollover— then the math for a Roth IRA conversion will probably not work out. And if you have to pay an early distribution penalty from the money you withdraw from your IRA to pay taxes on the rollover, the math really won’t work out.

On the other hand, if you have the money readily available — without using any of the money that's in your IRA now or in 2011 or in 2012 — you're in good shape to consider a rollover. The IRS is offering a one-time opportunity to spread the taxes due on Roth Conversions in 2010 out over 2011 and 2012. The math looks even better if you use an investment vehicle like Oil & Gas with Intangible Drilling Cost (IDC) deductions to offset the taxes in the years following the conversion. Of course Oil & Gas has specific suitability requirements and risks, but if Oil & Gas is right for you, then you should consider a Roth IRA Conversion.

· Is your IRA account balance down relatively speaking?

With the market drop in 2007 and 2008, the taxes due on a conversion are less than they would be had the market risen. This is just another thing to consider. If you account is down and you convert it now, the gains as it recovers in a Roth IRA will be tax-free.

· Do you need creditor protection?

Many states provide some measure of creditor protection to regular IRAs (although they aren't necessarily completely insulated). For reasons having to do with the way state bankruptcy laws are written, there's some question whether the same protections are available to Roth IRAs. So, if you have a reason to be concerned about creditor protection, you should consider this issue before performing a Roth IRA Conversion. And the issue is even more important if the money you're planning to roll to a Roth IRA is currently in an employer plan, protected by federal retirement law (ERISA).

So, as you can see, the change in Roth IRA Conversion tax rules opens a new opportunity in 2010, but the Roth IRA Conversion opportunity isn’t necessarily for everyone. Please don’t be led down a path that may not be in your best interest. There are many factors to consider. We developed a model to analyze each client’s specific needs, tax situations, and long-term goals to determine if it is in their best interest. Call us at 817-717-3812 if you would like for us to run the analysis for you.