Roth IRA Rollovers
If you have been thinking about rolling over amounts in your qualified employer-sponsored retirement plan accounts (such as 401(k)s and profit sharing plans) or regular IRAs, into Roth IRAs, now may be the time. Many taxpayers took advantage of the rollovers in 2010 when the availability was expanded and taxpayers could elect to defer the taxable income into 2011 and 2012. The ability to move your regular retirement plans into a Roth IRA still exists 2011, however there is no longer a 2 year deferral of the taxable income.
A Roth IRA is similar to other regular retirement plans in that the annual earnings of the plans is not taxable. The differences between the plans is in the year the funds are contributed and in the year funds are withdrawn.
Regular retirement plans provide a reduction from taxable income for the amount put into the retirement plans. However, when funds are withdrawn from a regular retirement plan they are 100% taxable. Also, you must begin withdrawing funds from a regular retirement plan when you reach age 70 ½ .
Distributions from a Roth IRA aren’t taxed if you meet the holding and age requirements. The Roth IRA owner also does not have to commence lifetime required minimum distributions at age 70 ½. Also, the amount contributed to the Roth IRA must be with “after-tax” dollars. There is no reduction in your income for amounts contributed to a Roth IRA.
The opportunity to take advantage of a Roth IRA roll over does come with a cost therefore. The rollover will be generally be fully taxed. For example, if your margin federal tax bracket is 28% and you roll over $100,000 from a regular IRA funded entirely with deductible dollars to a Roth IRA, you’ll owe $28,000 of tax. In essence, you are paying tax now for the right to future tax-free withdrawals and freedom from the RMD rules.
Should you consider making the rollover to a Roth IRA? The answer may be “yes” if you can pay the tax on the rollover with non-retirement-plan funds or if you anticipate paying taxes at a higher tax rate in the future than you are paying now. Many believe that tax rates for upper-middle income and high income individuals will trend higher in future years, and given the growth of compound tax free earnings, the Roth IRA roll over makes sense for many people.
Part of the answer involves how many years you can’t let the Roth IRA grow before you would begin to make withdrawals. It might also be a good idea to make the roll over if you have a number of years to go before you might have to tap into the Roth IRA as this will give you a chance to recoup (via tax-deferred earnings and tax-deferred payouts) the tax hit you absorb on the rollover. Another motivator might be that you are willing to pay a tax price now for the opportunity to pass on a source of tax-free income to your beneficiaries.
The decision to make a rollover to a Roth IRA needs to be carefully considered and discussed in the context of your family’s entire financial situation. If this is something you want to take advantage in 2011 then your planning needs to start now. Feel free to contact us if you want to better understand the tax impact of such a decision.
November 2011
Pursuant to IRS Circular 230, the Internal Revenue Service requires us to inform you that any tax advice included herein is not intended or written to be used, and it cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed by the IRS on the taxpayer. That said, please do not hesitate to contact us if you have any further questions regarding this matter.
