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Tax Tidbit 12/09: New Rollover Opportunities into Roth IRAs

There is an interesting new rollover opportunity that is coming up in a few months. After 2009, you will be able to roll over amounts in qualified employer sponsored retirement plan accounts, such as 401(k)s, profit sharing plans, and regular IRAs, into Roth IRAs, regardless of your adjusted gross income (AGI). Currently, individuals with more than $100,000 of adjusted gross income are barred from making such rollovers.

What's so attractive about a Roth IRA? Here is a summary:

• Earnings within the account are tax-sheltered (as they are with a regular qualified employer plan or IRA).
• Unlike a regular qualified employer plan or IRA, withdrawals from a Roth IRA are not taxed if some relatively liberal conditions are satisfied.
• A Roth IRA owner does not have to commence lifetime required minimum distributions (RMDs) after he or she reaches age 70½ as is generally the case with regular qualified employer plans or IRAs. (For 2009, there's a moratorium on RMDs.)
• Beneficiaries of Roth IRAs also enjoy tax-sheltered earnings (as with a regular qualified employer plan or IRA) and tax-free withdrawals (unlike with a regular qualified employer plan or IRA). They do, however, have to commence regular withdrawals from a Roth IRA after the account owner dies.

The catch, and it is a big one, is that the rollover will be fully taxed, assuming the rollover is being made with pre-tax dollars (money that was deductible when contributed to an IRA, or money that wasn't taxed to an employee when contributed to the qualified employer sponsored retirement plan) and the earnings on those pre-tax dollars. For example, if you are in the 28% federal tax bracket and roll over $100,000 from a regular IRA funded entirely with deductible dollars to a Roth IRA, you'll owe $28,000 of tax. So you'll be paying tax now for the future privilege of tax-free withdrawals, and freedom from the RMD rules.

Should you consider making the rollover to a Roth IRA? The answer may be “yes” if:

• You can pay the tax hit on the rollover with non-retirement-plan funds. Keep in mind that if you use retirement plan funds to pay the tax on the rollover, you'll have less money building up tax-free within the account.
• You anticipate paying taxes at a higher tax rate in the future than you are paying now. Many observers believe that tax rates for upper middle income and high income individuals will trend higher in future years.
• You have a number of years to go before you might have to tap into the Roth IRA. This will give you a chance to recoup (via tax-deferred earnings and tax-deferred payouts) the tax hit you absorb on the rollover.
• You are willing to pay a tax price now for the opportunity to pass on a source of tax-free income to your beneficiaries.

You also should know that Roth IRA rollovers made in 2010 represent a novel tax deferral opportunity and a novel choice. If you make a rollover to a Roth IRA in 2010, the tax that you will owe as a result of the rollover will be payable half in 2011 and half in 2012, unless you elect to pay the entire tax bill in 2010. If you believe there is a strong chance your tax rates will go up after 2010, you may want to consider paying the tax on the Roth rollover in 2010.

To discuss in more detail how a rollover into a Roth IRA might benefit you, please contact Andrew D. Ross, CPA of Bedard, Kurowicki & Co., CPA's, PC at (908) 782-7900 x 113, adr@bkc-cpa.com, or visit www.bkc-cpa.com.