Is a Roth IRA right for you?

Are you interested in tax free earnings? Are you in the fortunate position that you may have more assets than you will need in retirement and wish to leave more to your heirs? Have you had an unusual year and your taxable income is very low or zero? Do you think your effective income tax rates in the future will be higher than today? Are you trying to manage your taxable estate? If you answered yes or maybe, keep reading. You will find ideas that may be of interest to you.

A Roth IRA is an individual retirement account that upon inception is designated as a Roth IRA in order to qualify for taxfree growth. This type of retirement account allows a retiree to enjoy tax-free income during retirement. In addition, if you do not need the income during your retirement you are not required to take required minimum distributions (RMDs).

Traditional IRAs come in two types: deductible and nondeductible. As their names indicate, a deduction is available for the contribution to a deductible IRA. This gives an immediate income tax benefit for the year of contribution. There are numerous limits to funding a traditional deductible IRA which should be explored prior to funding. There is no deduction for contributions to a nondeductible IRA and there are far fewer limits on a taxpayer wishing to make such a contribution. Both come with the benefit of tax deferred earnings and both come with a requirement to start taking distributions when the account owner attains the age of 70 ½. Please note, tax deferred and tax free are very different. Deferred taxes simply delay the payment of taxes on earnings until the funds are withdrawn from the account. Additionally, if you made deductible IRA contributions, the entire amount withdrawn in retirement will be treated as ordinary income and subject to income tax.

Roth IRAs have income limitations for contributions but if you qualify, a contribution may be made at any age. Additionally, if you do not qualify to contribute to a Roth, you may be able to make contributions to a traditional nondeductible IRA and then do a conversion to a Roth. There are numerous situations and facts to be considered, but this may prove to be a very attractive option. Additionally, many people have IRAs as a result of rollover contributions from prior employer sponsored retirement plans. These are typically traditional IRAs and can be converted to a Roth IRA.

Is estate tax your primary concern? If so, traditional IRA accounts can be converted to Roth IRAs. This will cause current year taxable income, resulting in immediate income taxes. This is clearly a major consideration and is not going to be right for many, but if you are trying to reduce your taxable estate and avoid RMDs, this may be helpful.

There are other situations where the triggering of current year income maybe beneficial. Are you losing the benefit of itemized deductions? Do you have expiring charitable contributions? Are you about to finish a tough financial year with income so low you will be in a very low tax bracket for the first time in years? All of these situations may warrant the desire to generate taxable income. A Roth IRA conversion will not only trigger the taxable income and keep the money in a retirement account but also convert all future earnings to tax-free income.

Unforeseen circumstances cannot hurt you under the Roth IRA. You have worked with your tax advisor and walked through all the considerations applicable to your personal income and/or estate tax situation(s). You do all the calculations and you convert some or all of your retirement funds to a Roth IRA and have triggered the income and the related tax. The year ends and you discover there was some unknown event causing you to wish you had never done the Roth conversion. As an example, market fluctuations can be helpful or hurtful when converting to a Roth. If hurt, no problem; confirm the problem with your tax advisor and do a recharacterization of all or part of your Roth conversion. The recharacterization is the “do-over”. If done by the due date of the return, including extensions, it is as if the Roth conversion never happened.


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