Is Converting Your IRA to a Roth IRA Still a Good Idea?
You may recall the hype that last few years over converting a traditional IRA account to what is known as a Roth IRA. It was especially so when the conversion rules were opened up to all taxpayers regardless of income, and any resulting tax from the conversion was given a limited time spread over a couple of years.
To give you a little background, Roth IRAs were the brainchild of Senator William Roth of Delaware in the Taxpayer Relief Act of 1997. The big difference between a Roth and a traditional IRAs is that there is no tax deduction for a contribution to a Roth IRA like there is a traditional IRA. The Roth IRA grows tax-free just like the traditional one, but you don't have to pay any tax upon withdrawal at retirement, assuming you have held it at least 5 years.
In addition, Roth IRAs aren't subject to the required minimum distribution rules to which traditional IRAs are subject, so you don't have to begin withdrawals from your Roth IRA at age 70 ½.
Originally, Congress limited who could contribute or convert to a Roth based upon income. As a result, those whose incomes were above certain limits were unable to take advantage of the Roth's benefits.
However, beginning in 2010, the income limits for conversions (as opposed to contributions) from traditional to Roth IRAs were removed. This opened a window of opportunity for all taxpayers, regardless of income, to convert existing traditional IRAs to Roth IRAs, thus obtaining the benefits.
This window was made more appealing by the fact that if the conversion took place in 2010, any income resulting from the conversion could be recognized and the tax thereon paid one-half each in 2011 and 2012.
You see, converting a traditional IRA to a Roth is not without cost, as income tax must be paid on the date of conversion value of the IRA over the basis, if any, you have in the IRA. This special rule allowed that to be stretched over 2 years.
That two year spread is no longer available, meaning all income and related tax must be dealt with in the year of conversion, a fact which has many questioning whether a conversion is still a viable opportunity.
In short, I believe the answer to that is "Yes", it still may be something you should consider for a variety of reasons, especially in 2012.
First is the real possibility of a rise in income tax rates in the future. Conversions now will lock in the inherent taxable income at today's tax rates. If rates go up, you will not only have saved the difference on the current taxable value of your IRA, but also sheltered future growth from all tax. And conversions in the future will be more expensive as well.
Second, you may have heard about the new 3.8% Medicare tax beginning in 2013 that will be imposed on the unearned income of taxpayers whose incomes exceed certain thresholds ($250,000 for joint returns, $125,000 for married filing separate returns and $200,000 for all others).
While the IRA conversion income is not considered unearned income subject to this tax, any income recognized upon conversion could push someone into the higher income threshold, causing them to pay tax they otherwise would not have to pay. Converting in 2012 prevents this from happening.
Likewise, future taxable distributions (including required minimum distributions after age 70 ½) from traditional IRAs could also push you into the income area that causes this tax to apply. Because Roth IRA distributions are never taxable, that problem is avoided as well.
Finally, Roth IRAs offer other advantages over traditional IRAs.
From an estate planning perspective, beneficiaries also receive distributions from a Roth IRA income tax free. And because you never have to take a distribution from a Roth, you can accumulate even more in the Roth to leave to your heirs.
In addition, unlike traditional IRAs, you can contribute to a Roth IRA for every year you have taxable earned income, including the year you reach age 70 ½ and every year thereafter.
So, don't avoid the discussion about converting your IRA to a Roth IRA just because the two-year spread is no longer available. There are still advantages to be had, after of course, careful consideration of the costs involved.
