Start Maximizing your IRA Contibutions

By Mark W. Feucht

Two tax laws scheduled to take effect in the near future will combine to create new opportunities for you to convert your traditional individual retirement accounts and company plan balances to Roth IRAs. .

The Tax Increase Prevention and Reconciliation Act, signed into law May 17, allows people to convert their traditional IRA balances to Roth IRAs beginning in 2010 by removing the income and filing-status restrictions.  In addition, Congress has included an attractive payment plan to encourage IRA owners to convert.

Currently, if you are eligible to convert, the conversion income is taxed in the year of the conversion.  But for conversions done in 2010, the taxes can be spread ratably over two years and included in income for 2011 and 2012. That isn’t a typo: No tax will be due in 2010 (the year of the conversion).

Then, under the Pension Protection Act of 2006, company plan funds can be converted to Roth IRAs – beginning in 2008 – without first having to roll those funds over to an IRA and convert to a Roth IRA from there.  Even though these provisions don’t take effect for a while, there are planning moves that can be made now.

If considering a conversion, start maximizing IRA contributions.  Deductibility of the contribution shouldn’t be the primary issue, since paying the tax now means that less tax is paid at the time of the conversion.  If your income limits the amount deductible, you should consider maximizing your contribution into non-deductible traditional IRA’s, which can be converted in 2010, regardless of income.

As much as I don’t like non-deductible IRAs, because of the tax reporting, this is a time I will recommend them if the intention is to convert those funds into Roth IRAs in 2010.  The more you have in a traditional IRA (deductible or non-deductible), the more that can be converted in 2010, taking advantage of the generous tax payment plan.  Of course, we should calculate the amount that realistically can be converted without throwing you into a higher tax bracket.

However, even if you convert in 2010, you can’t just convert the non-deductible IRAs to a Roth IRA and pay no tax at all.  If you have other IRA funds (even in other accounts), then you have to factor in those funds, and some funds converted will be taxable based on the amount of the tax-free funds compared with the total amount in your IRA.

Review all the IRAs and company retirement plans that you now have and see if contributions to those plans are being maximized.  If planning to convert, consider contributing as much as possible to all available plans, knowing that in 2010, any funds in company plans, traditional IRAs, or SEP or SIMPLE IRAs can be converted, and the tax won’t have to be paid until 2011 and 2012.

If you are thinking about doing a large Roth conversion soon then you should consider waiting until 2010 to do it so you can spread the tax bite over two years instead of paying it all at once.  If you plan to do a conversion in 2010, you would have four years – 2008 to 2011 – to accumulate the funds necessary to pay the income taxes on the conversion.

This tax law doesn’t affect the income limits for contributions to a Roth IRA.  Those limits still stand but can easily be bypassed in 2010 and later years by making a traditional IRA contribution and then doing a conversion to a Roth IRA in the same year.

So keep in mind these new tax incentives to set up Roth IRAs, and the long-term tax advantages of a Roth IRA.  The tax is paid upfront – and you get this one-time break to get a free ride for 2010 and not have to pay the tax until 2011 and 2012 – and the account will grow tax deferred with the opportunity for tax-free qualified withdrawals forever.  Also, there are no lifetime required distributions for Roth IRA owners, so the funds can keep growing income tax free and be passed on that way to beneficiaries.

Roth IRA beneficiaries who are non-spouses must take required minimum distributions, but the distributions generally will be tax free and can be stretched over their lifetime, providing a tax-free legacy.

As tax rates rise, which is very likely, the value of Roth IRAs with their qualified tax-free withdrawals will skyrocket.

Mark W. Feucht is a CERTIFIED FINANCIAL PLANNER^TM practitioner and accredited tax advisor. His practice that is located in Fond du Lac specializes in financial services and tax planning & preparation. He can be reached at 920-921-6288 or mark.feucht@feuchtfinancial.com. Securities Offered through National Planning Corporation, Member FINRA / SIPC. Feucht Financial Group, LLC & NPC are separate and unrelated companies.

 

Securities and advisory services offered through National Planning Corporation (NPC), Member FINRA / SIPC, a Registered Investment Advisor. Feucht Financial Group, LLC and NPC are separate and unrelated companies. See Home Page for full disclosure.