Money Power: Converting IRA to Roth may be wise as tax rates change
BY SANDRA BLOCK Money Power
Sunday, November 18, 2012
11/18/12 at 3:13 AM
Tax planning is stressful even under ordinary circumstances, and this year is anything but ordinary. Unless Congress acts by Dec. 31, tax rates on wages and investments will rise.
If you think your tax rate is going to rise sometime in the future, converting a traditional IRA to a Roth makes sense. Withdrawals in retirement from traditional IRAs are taxed at your ordinary income tax rate.
But withdrawals from Roths are tax-free and penalty-free, as long as you're at least 59 1/2 and the converted account has been open at least five years. You will have to pay taxes on any pretax contributions and earnings in your traditional IRA in the year you convert. That's why converting before New Year's Eve could be smart: You'll pay taxes at current tax rates.
If you're an upper-income taxpayer - with modified adjusted gross income (AGI) of at least $200,000 if you're single or $250,000 if you're married filing jointly - you have an even greater incentive to convert in 2012.
That's because converting next year could trigger a new 3.8 percent surtax on unearned income (the surtax was enacted to help fund the health-care reform law). Withdrawals from an IRA aren't subject to the surtax, but they're added to your adjusted gross income and could lift your AGI above the threshold.
There is a big caveat, though. We think a major tax-reform package could be enacted as early as next year that would lower overall tax rates while eliminating tax credits and deductions. If that happens, you'd be better off not converting this year.
Fortunately, when you convert to a Roth, you can change your mind, says Kathy Stewart, director of fiduciary research for fi360, a training organization for financial advisers. If it looks as if tax reform will lower your tax rate, you'd still have until Oct. 15, 2013, to undo the conversion and turn your Roth back into a regular IRA.
Another caveat: Converting to a Roth is rarely a good idea if you do not have enough money outside your IRA to pay the taxes. And don't overlook any tax liabilities from previous conversions. In 2010, Congress allowed taxpayers who converted a traditional IRA to a Roth to split the taxable income between 2011 and 2012. If you still owe taxes on a 2010 conversion, the income from a 2012 conversion could push you into a higher tax bracket.
Original Print Headline: Converting IRA to Roth may be wise
Sandra Block is a senior associate editor at Kiplinger's Personal Finance magazine. To send her a question or comment, go to tulsaworld.com/kiplingerfeedback.