To be eligible to convert a Traditional IRA to a Roth IRA, a person must have an adjusted gross income (AGI) of $100,000 or less regardless of marital status. Often, individuals age 70 1/2 or older want to convert to a Roth IRA to avoid required minimum distributions (RMDs) from their Traditional IRA. In many cases, these individuals are ineligible for a conversion because any RMDs received by the individual must be taken into account when determining their AGI limit.
Good news! Beginning January 1, 2005, required minimum distributions are no longer included in adjusted gross income calculations. This change in the income formula means more individuals are now eligible for a Roth conversion!
- Desire to pass IRA assets to heirs that are free from federal tax
- Are over age 70 1.2 and previously ineligible for a Roth conversion because your RMDs cause your AGI to be over $100,000
- Are nearing age 70 1.2 and have an AGI of less than $100,000
- Do not need RMDs to sustain your standard of living
- Have access to other assets to pay the income taxes associated with a Roth conversion
- Believe future tax rates will be higher
It is important to note that you must take your 2005 required minimum distribution from your Traditional IRA prior to converting to a Roth IRA. Also, extra taxable income due to a Roth conversion could impact the ability to take advantage of certain itemized deductions because the deductions phase out at higher AGI amounts.
Your financial advisor can assist you with IRAs and other retirement planning options. Contact your financial advisor today to implement the comprehensive wealth management solutions you deserve.
What are the advantages and disadvantages of converting to a Roth IRA?
Since the introduction of the Roth IRA, many people have converted all or a portion of their existing Traditional IRAs to Roth IRAs. A conversion has both advantages and disadvantages that should be carefully considered before you make a decision. Some advantages are:
- A lower tax bill in the future
- The ability to invest a larger dollar amount in a federally tax-free vehicle by using other savings to pay tax on the conversion âˆž Your money may be invested in a tax-free vehicle for a longer period of time by avoiding required minimum distributions (RMDs) after age 70 1/2
- A reduced estate tax when you pay income tax on your IRA before you die (as you have already paid income tax, thus reducing the size of your estate). Also, upon your death, your Roth IRA will pass to your beneficiaries free from federal (and often state) income taxes. However, estate taxes continue to be payable.
A key potential disadvantage of converting a Roth IRA is rate shifting. This occurs when you pay a conversion tax at a higher rate than what you would have paid if you had left the money in a Traditional IRA and withdrew it later. Another issue to consider would be whether you have enough funds to pay the conversion tax. If the characteristics described above do not apply to you, or if you have concerns regarding the potential disadvantages of converting, talk to your financial advisor to discuss your options.