Roth IRA Conversion – The Benefits Most Aren’t Considering?

2010 is an interesting year with the income limits disappearing for the Roth IRA Conversion, meaning anyone can convert their IRA to a Roth and potentially never pay taxes again on that money.

Now to understand the benefits I’m going to talk about you first have to understand when and how you will be paying your taxes.  When you convert an IRA to a Roth IRA in 2010 you will have the option of paying your taxes due on your 2010 tax return or you can take advantage of a 2010 rule allowing you to pay half of them in 2012 with your 2011 tax return and the other half in 2013 on your 2012 tax return;  your choice.  Once you figure out when you will be paying your taxes you next have to figure out how you will be paying your taxes.

Paying these Roth Taxes aren’t as easy as you think.  If you are under the age of 59.5 you cannot just use money from the IRA you are converting because any money withdrawn from an IRA before age 59.5 will have an additional 10% penalty.  You really need to have money in a Non-Qualified (Not an IRA, 401k, 457, or 403b) account available to pay the taxes.  This is where a major benefit occurs.  Most people just look at tax rates now and expected tax rates in retirement to evaluate the benefits of a Roth IRA conversion.  Although that is the most important concept to evaluate when deciding which IRA to contribute to; evaluating a Roth Conversion is a bit more complex.  If you do a Roth conversion and pay the taxes from a non qualified brokerage account you will be getting another benefit as well - no more capital gains tax on the money used to pay the taxes.

If you assume that all your taxable funds were able to take advantage of Long-Term capital gains (best scenario possible) and you live in California making more than $47,055 per year you will pay 24.55 % capital gains (15% for Federal and 9.55% for state).  Once you pay your Roth Conversion taxes you will never pay taxes on this money again.

Let’s look at a 50 year old planning to retire at age 66 (Full Social Security Age) with a $100,000 in an IRA and looking to convert it to a Roth.  Let’s assume their current state and federal income tax bracket is now at 35% and will reduce to 30% in retirement.  For capital gains will assume 24.55% capital gains tax rates.  We will also assume a 7% rate of return.

In this example they will owe $35,000 in taxes this year for the conversion from a traditional IRA to a Roth IRA.  At retirement (age 66) the Roth IRA will be worth $295,216, your IRA would also be worth $295,216 but taxes would be due and would only be worth $206,651 (assuming you paid the taxes at 30%).  To compare apples to apples you would also need to assume you had invested the $35,000 that you didn’t pay taxes with, and earned the same rate of return as your other investments, 7%.  That $35,000 would be worth $103,325.73.  Assuming that all of your gains on that $35,000 investment were taxed at capital gains you would owe (or have paid) $14,721 in taxes.
Now if you compare your options both on an after tax basis you will see that converting your IRA to a Roth IRA would generate an economic benefit of $14,721.  For more information or to receive our Roth IRA calculator please visit www.AnnuityRateShopper.com or call us at (888) 515-7152.

This entry was posted on Monday, March 22nd, 2010 at 5:10 pm by ryan and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.