By Dr. Shelby Smith
of The Retirement Pros
The Roth IRA has existed for ten years but is under utilized by financial advisors and retirees alike. Converting your retirement money to a Roth IRA holds outstanding potential, but unfortunately many that need it most cannot qualify and most that can qualify have bypassed the opportunity. You can qualify if your total annual income is not more than $100,000. While higher income individuals cannot currently convert qualified retirement money to a Roth IRA, the income limit will be suspended in 2010. If you can qualify now, you need to immediately check into this opportunity. If you do not currently qualify, now is the time to start preparing for 2010 when you can. Following are suggestions you may find helpful.
As I mentioned in this retirement blog, the reasons for converting IRA, 401(k) and other retirement moneys to a Roth IRA are many. Among the most important is that principal and earnings withdrawn from a Roth are not subject to income taxes. This tax-free status survives the death of the owner and is passed to the spouse and beneficiaries. The non-spouse beneficiary must start Required Minimum Distributions (“RMD”) but can stretch withdrawals over their life expectancy – with every withdrawal being totally tax-free. If future tax rates rise – and the consensus opinion is that they will – paying the taxes now on retirement accounts could make a great deal of sense. If you plan to pass the money forward to heirs, their prospective tax rate must also be taken into consideration. If your current retirement accounts are depressed in value – and most are – it is smart to buy out your partner (the IRS) at rock bottom prices (smaller accounts mean fewer taxes). There are numerous other advantages to a Roth conversion which can be found in the book Go Roth by Kaye A. Thomas (Fairmark Press, 2009).
If your retirement money is now in a 401(k), it probably cannot be moved to a Roth IRA because most 401(k) Plans allow withdrawals only upon death, retirement, termination, disability or financial hardship. But, there is a little known provision in the Employee Retirement Income Security Act (“ERISA”) of 1974 that permits some or all 401(k) money to be trustee-to-trustee transferred regardless of age, without triggering taxes, while still working for the same employer and without giving up participation in your employer’s 401(k) Plan. This escape hatch is called an In-Service, Non-Hardship Withdrawal provision and is fully explained in Tapping into Your 401(k) Money before Retirement, a book I co-authored and is available free at theretirementpros.com. Thus, if you currently have your retirement money in a 401(k) Plan but might want to covert some or all of it to a Roth IRA now or in 2010, talk to your employer about changing your 401(k) Plan by adding the In-Service, Non-Hardship Withdrawal provision. This provision is easy to add, can be done immediately and cost your employer nothing. The exact steps are explained in my book referenced above.
While Required Minimum Distributions are not required for qualified retirement accounts in 2009, they will again become effective in 2010. If you are currently taking RMD from your retirement accounts but wish to avoid them, a conversion to a Roth IRA may be the answer. You, and your spousal beneficiary, are exempt from RMD if your money is in a Roth IRA. Parenthetically, not having to count Roth withdrawals as income in future years will yield dividends in two ways:
-- Keep you in a lower tax bracket overall;
-- Shelter more of your Social Security money from income taxation.
A Roth conversion is not for everyone, but you may be able to benefit and, therefore, need to investigate the opportunity. You’ll hear a lot more about Roth conversions as we get closer to 2010. If you think converting to a Roth IRA makes sense, talk to your financial advisor about the specifics. Also, learn all you can on your own by referencing the Newsletter, articles and webinars on TheRetiriementPros.com and read the books I’ve mention above. This is a great opportunity for you to shelter some or all of your retirement money from income taxes without taking risks, but you’ll need to start preparing now.