A Golden IRA Opportunity

In these shaky economic times, there are not a lot of good financial opportunities out there, but I have discovered one that might interest you. It is rooted in the Individual Retirement Account (IRA) and it has some nice benefits.

If you have such an account, known as a traditional IRA, it is something that you may have had for several years, and you might have put money into it off and on over time. It might be your primary retirement account, or it might be something that you have in addition to your employer’s pension or 401(k) plan. In any event, if you have a traditional IRA, there are some things about to happen.

If you recall, when you put your money into the account, that deposit was deducted from your income tax. That meant that the deposit into the IRA was ‘pre-tax’ money that would have to be taxed at some later point. The theory was that it would be taxed when you pulled it out of the account, which would probably be when you retired and your income tax rate would be lower. In any event, eventually it would have been taxed.

Then, several years ago, the Roth IRA was introduced, which was funded with money that was already taxed when it went into your Roth, and would not be taxed when it came back out. Along the way, all of the growth would be tax-free, too. The government was trying to encourage us to save money, since pension plans, like disco music, had gone out of style.

Some folks started talking in recent years about the best of both worlds by allowing people with a traditional IRA to combine it with or convert it into a Roth IRA. There is a little known but soon to be widely publicized portion of the tax law that allows that conversion, and in 2009 and 2010, that opportunity is going to be made much more available.

So what is the big deal with the Roth IRA? The money that you put into it is after-tax money. The growth (capital gains) and earnings (dividends and interest) are not taxable as it grows, and none of that is taxed when you take it out. Also, under a traditional IRA, you must begin to withdraw your money after you turn 71, but with a Roth IRA, you never have to take the money out. At the time you die, the traditional IRA is taxed as a part of your estate, while the Roth IRA is not, and it can be left to your spouse, children or grandchildren, or even to a charity as you see fit.

So how can you take advantage of this opportunity? There are two answers: a 2009 answer and a 2010 answer. The 2009 answer is that if your income is below $100,000, you can convert your traditional IRA to a Roth IRA, but you must pay income tax on the taxable portion of it. In order to know what that tax bill is, you will need to ask your tax professional to help you or work it out for yourself. Since income tax rates are at a historic low right now, however, it looks like a good time to do this. Those low rates, coupled with the rather depressed state of all investments, may make this a superb time to convert. And the IRS will be so happy to have you pay income tax on your IRA that they will give you a couple of years to pay it.

The second answer is for 2010 and thereafter, when the annual earnings limit of $100,000 is removed. Then, everyone with a traditional IRA will be able to take advantage of this conversion opportunity. Again, you will have a two-year period over which you can pay your tax, even though the income tax rates might have inched up under the new administration. If your portfolio of investments hasn’t bounced all the way back by then, it still might be a great time to convert.

In summary, if you are thinking of converting at all, 2009 offers you some absolutes in terms of amounts and tax rates, so you can predict your outcome. 2010 still presents a good opportunity, but there are some variables that we cannot predict with certainty, so you are gambling a little if you wait.

As with most things financial, you would be wise to consult your tax advisor, your investment advisor, and of course, your estate planning lawyer. Your Roth IRA is a part of your estate plan and you want to make certain that you are doing the right thing and not skewing some other factor of your overall plan.

Christopher M. Abernethy has been practicing law in Hampton Township since 1976. He focuses on elder law, which includes wills, trusts, powers of attorney, living wills and probate matters. He also is proficient in all aspects of real estate law and business law. He is a member of the National Association of Elder Law Attorneys and the AARP Legal Services Network. He can be reached at (412) 486-6624 or by email at cabernethy@aaylaw.com.