NORTH BAY – In 2010 for the first time, anyone, regardless of income, will be able to convert traditional Individual Retirement Accounts to a Roth IRA.
Since the legislation was written in 1998, only people with modified adjusted gross income of less than $100,000 could make the conversion.
If an individual wants to convert a traditional IRA to a Roth IRA, he or she will have to pay federal income taxes on any pre-tax contributions as well as any growth in the investment's value. Once converted to a Roth, however, all of the investment can be withdrawn on a tax-free basis once certain conditions are met.
There are both benefits and pitfalls to making this conversion.
Traditional IRA contributions are not taxed. Distributions are taxed, and the holder of the account must start to take distributions at 70 1/2 whether they need or want to or not.
So a benefit for converting to a Roth IRA is distributions are tax-free and are not required after the account holder reaches 70 1/2. But the tax must be paid upfront.
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The tax rates in the next 10 to 15 years will change, said Steve Goldberg, estate planning attorney and partner at Friedemann Goldberg in Santa Rosa, making this a good time to make a conversion.
“The idea is to pay the tax in the depressed tax rate,” Mr. Goldberg said.
But it depends on when the account holder wants to pay the tax.
If, for instance, the account holder of a traditional IRA is going to leave the account to a beneficiary, converting to a Roth IRA will mean no taxes when the money is withdrawn by the heir.
But if the person thinks they may live off the funds and will take most out of a traditional IRA in the next few years, it may be better to leave it where it is.
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“It is about weighing what the individual wants today and what they want to leave behind for their heirs,” said Joni Fristsche, a director with Burr Pilger Mayer in Santa Rosa.
A major fear is that the income tax may be pushed to a future generation at higher rates. And one of the factors that could play a role is if Congress, as expected, doesn’t extend the Bush tax cuts.
If not, tax rates will revert to 2001 levels, making the top four brackets 39.6 percent, 36 percent, 31 percent and 28 percent from what they are now, 35 percent, 33 percent, 28 percent and 25 percent.
Another choice to make is if the conversion is made, the account holder can opt to pay all the tax in 2010, or half in 2011 and half in 2012.
Ms. Fritsche said that this is a delicate decision, particularly for high-net-worth individuals.
If, for instance, an IRA had $8 million and the account holder died, the estate would be taxed at the 45 percent tax rate.
Then, assuming the children or beneficiaries were also in the high-income bracket, they would face additional tax liability of 35 percent federal and 10 percent California when the money is withdrawn.
