Prior to 2010, there were income limitations which precluded many individuals from converting traditional IRA’s into Roth IRA’s and reaping the benefits of tax free growth and tax free withdrawals. Although these limitations still apply to funding Roth IRA’s, beginning in 2010, the earnings limitations were eliminated for converting traditional IRA’s to a Roth IRA.
But there is no free lunch. Upon conversion to a Roth IRA, individuals must pay income tax on the value of the tax deductible contributions to the traditional IRA and the tax-free growth in the traditional IRA assets. If the traditional IRA is converted to a Roth IRA in 2010, then this income tax can be spread over two years and included in income in 2011 and 2012. So once the income tax is paid, the balance inside the Roth IRA grows tax free and can be withdrawn tax free.
You should discuss with your financial advisor whether or not an IRA conversion makes economic sense. Among the factors to consider are whether you can pay the tax with non-retirement assets; do you intend to leave the assets inside the Roth IRA for several years (or even better, you do not intend to use them at all for your retirement); and whether you anticipate a high income tax rate even if you are retired. (Does anybody believe tax rates may be increasing?)
Whether or not you take advantage of a Roth IRA conversion, it is important to tie your beneficiary designations into your estate planning objectives.
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