CONVERSION TO ROTH IRA: TIME TO ACT IS BEFORE 2011
OCTOBER 2010 | BY: JOEL LUBER, ESQ.
While everyone in the estate planning community continues to hold their collective breath waiting for Congress to decide what to do about the estate tax law (and income tax rates), one part of the law that brought us all of this uncertainly continues to be certain. And it is one that perhaps is not receiving the attention that it should: Whether to convert a traditional IRA into a Roth IRA.
The decision to convert a traditional IRA into a Roth IRA is one that must integrate a number of factors and assumptions about the future. The primary factor is the income tax liability that will be triggered by the conversion. Then a number of variables must be applied, including (i) your ability to pay this tax, (ii) the source of payment, (iii) an initial assessment as to whether tax rates will rise in 2011 and 2102 over the rates in 2010, and (iv) a prognosis of the tax rates that may be in effect on the date of retirement, or the date you otherwise are prepared or must start taking distributions from the account.
As a general rule of thumb, if you do not have the resources to pay the tax on the amount converted, other than from the IRA account itself, unless you plan on never taking a distribution from the now converted Roth IRA, the economics dictate against conversion. For those under age 59-1/2, and without other resources, conversion is even more unlikely to be a good idea, because any amounts not contributed to the Roth IRA will not only be subject to income tax, but a 10% early withdrawal penalty as well.
“...it is highly recommended that everyone consider opening a Roth IRA this year with a contribution or conversion of at least $1.00.”
The waiting period is five (5) years. That is, distributions from a Roth IRA that is created from a conversion are tax free only after the account has been in existence for a period of five (5) years. Therefore, it is highly recommended that everyone consider opening a Roth IRA this year with a contribution or conversion of at least $1.00. Then, regardless of a decision to convert at any time later this year, or in future years, you will be able to take advantage of tax free distributions as early as January 1, 2015.
We, at Offit Kurman, stand ready, willing and able to assist with the proper analysis of all of these factors for anyone who believes that converting their IRA into a Roth IRA may be the right thing to do.
WHY BEFORE 2011?
For conversions completed in 2010, one has an election on when to pay the tax. The default rule is that one half of the amount is reported in 2011, with tax due April 15, 2012, and one half of the amount is reported in 2012, with tax due on April 15, 2013. But one can elect out of the default rule and report the full amount in 2010, and pay the tax on April 15, 2011. Thus, while deferral in the payment of taxes is normally a good idea, the question becomes whether the rates will be higher in 2011 and 2012 than they are this year.
If you believe your taxable income will be substantially less in retirement than it is now, then it may not pay to convert and incur a tax today at a higher rate. If you believe your income will be substantially higher in these later years, or that tax rates will be substantially higher, then it may make sense to convert and pay the tax now at a lower rate in order to reap the benefits of the two significant advantages of the Roth IRA, they being (i) there are no mandatory distributions during the account owner’s lifetime; and (ii)all “qualified” distributions (after a waiting period of five years) are income tax free.
Any contribution to a Roth IRA during any calendar year is given retroactive effect to January 1 of the year; and a contribution of even $1.00 to a Roth IRA starts the five year clock running for all Roth IRA accounts for which a contribution was made to any Roth IRA account at any time thereafter.
Joel Luber is a Principal with Offit, Kurman, P.A.. He concentrates his practice in sophisticated estate planning for high net worth clients and can be reached at 267.338.1316 or jluber@offitkurman.com.
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