Do You Need An IRA?

Do You Need An IRA?

By Kimberly J. Howard

IRAs are not new, but with the outlook of future higher income taxes, it makes more since to contribute to a Roth and have tax-free distributions in the future. Prior to 2010, there was a $100,000 Adjusted Gross Income (AGI) limit. This meant that anyone, single or married, with AGI limit over $100,000 was not allowed to convert from a Traditional IRA to Roth IRA. Now, the laws have been changed to allow anyone to convert.

Individual Retirement Accounts (IRAs) are a great retirement savings tool for most people. Traditional IRAs are set up with pretax dollars, and you pay income tax on the full amount when you withdraw money. Roth IRAs are created with after-tax dollars, and your money grows tax-free. This means you won’t pay income taxes when you take money out of the account.

What is an IRA conversion? It’s a process of moving your money from a Traditional IRA to a Roth IRA. The downside is that you’re required to pay income taxes on the converted dollars at conversion time, but your money grows tax-free.

The savings for an IRA conversion will vary according to you income tax bracket. The higher your tax bracket the more you will be paying in income taxes at conversion time. If you must take out money from your IRA to pay the conversion income taxes, then it will take you much longer to reach a break-even point. If you expect to be in a higher tax bracket when you retire, then converting now may make sense.

Advantages to Converting to a Roth IRA:
-Avoid Taxes in the Future: Roth IRAs grow tax-free. Therefore there won’t be any taxes owed when you decide to withdraw money.
-No Required Minimum Distributions (RMD): Roth IRAs don’t require RMDs after age 70 ½, so your money can continue to grow with the potential for larger dollar amounts to leave to heirs.
-Lower Balances to Convert: Due to the recent market downturn, most people have lower balances, which means there will be less taxes paid on the conversion.
-Spread Taxes Over Two Years: The federal government is also allowing income tax due on your 2010 conversions to be split between 2011 and 2012.

Prime Candidates for Roth IRA Conversion:
-People who think they will be in a higher income tax bracket in the future. Since Traditional IRAs require RMDs and RMDs are taxed at your marginal tax bracket, then it is better to pay taxes now on the converted amount than pay taxes in retirement.
-Younger individuals will have more time to recoup income tax payments on the conversion. The quicker you reach the breakeven point the better off you will be.
-If you think you will not need the money for retirement, then the conversion allows you to not take RMDs.

Women Who Should Think Twice:
-If you don’t have the money to pay the income taxes on the converted amount, then converting to a Roth IRA is probably not a wise choice.
-If you think you’ll fall into a lower tax bracket in the future, leave your money in your Traditional IRA and pay the taxes on future RMDs.
-If a do-it-yourselfer, be sure and check IRS Publication 590 (Individual Retirement Arrangements) – it will explain the finer details about conversions. -Or, consult a tax specialist or financial advisor to help with details to avoid any overlooked requirements. Check out all options and see if the Roth IRA conversion is a good idea for you.

Kimberly J. Howard, CFP®, CRPC® is a Certified Financial Planner and the owner of KJH Financial Services, a Fee-Only practice located in Needham, MA. Find her at www.kjhfinancialservices.com or kim@kjhfinancialservices.com