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Roth IRA Conversion Rules Changing – Have You Reviewed Your Tax Plan – Part III

roth_ira_conversionThis is Part III of a series of post related to Roth IRA Conversions and the rule changes that go into effect on January 1, 2010.  As mentioned in prior post of this series regarding Roth IRA Conversions, I will explain the rules around Roth IRAs, as well as what the recent changes in the law means. I will also provide you with some reasons to convert, as well as some reasons not to convert. In addition, my final posts will include some tax planning tips around the Roth IRA.

For other posts in this series, please visit:
Part I:  What is a Roth IRA? What is changing about Roth IRA Rules?
Part II:  Reasons to Convert to a Roth IRA. 
Part III:  Reasons NOT to Convert to a Roth IRA.
Part IV:  Planning Ideas around Converting to a Roth IRA.
Part V:  Planning Ideas – What is the Pro-Rata Rule?

In this post, I will explain some of the common reasons that you will want to consider for not converting to a Roth IRA.  It is important to keep in mind that everyone’s situation is different and that these reasons may or may not apply to you.  You should sit down with your tax professional and do proactive tax planning prior to doing anything. 

Reasons NOT to Convert to a Roth IRA. 

Taxes!  If you convert your traditional IRA to a Roth IRA, you will most likely have to pay income taxes on the amount of your pretax contributions and earnings that are included in the amount that you convert.  If you have $100,000 sitting in your retirement account, this could be a hefty tax bill to absorb.

It is usually not a good idea to convert to a Roth IRA  unless you have other sources from which to pay the taxes other than retirement funds.  Depleting these funds to cover the taxes, offsets the positive benefits derived.  Another downside to paying these taxes with retirement assets is that you are “locking in” you losses that you have experienced over the last couple of years.  Once you cash these investments in, there is no chance for recovery.  In addition, if you are not 59 1/2, you would likely have to pay a 10% tax penalty on the funds you withdraw to pay the tax.

Possibility of Future Surcharge on the “Rich.”  As stated in Part I, under current law, distributions under Roth IRA’s are to be tax free since the tax was paid at the time of the contribution.  The key word there is “current law.”  We have no way of knowing what Congress will do in the future as it becomes more and more desperate to raise tax revenues for its never ending laundry list of government programs and agencies.  There is a possibility that at some point in the future Congress will find it “necessary” to tax a portion of Roth IRA distributions for “wealthy” Americans.   While most politicians will say this will not happen, keep in mind that they also told us that no portion of Social Security benefits would be taxable since it had already been taxed once.  

When our country was formed, our founding fathers were vehemently opposed to the income tax.  It wasn’t until the ratification of the 17th amendment in 1913 that the income tax was Constitutional.  At that time, we were assured by our politicians that it would never need to go above one to two percent, and that it would only apply to the wealthiest Americans.  Well, we have all seen how that promise played out.  My point is that most of the publications and articles I read on the Roth IRA assume that all distributions will always be tax free.  Keep in mind that they may not be.

Fair Tax.  Another possibility that we must be aware of is what happens if the Fair Tax or something similar ever becomes law?  What if there is a total transformation of our tax system in which the income tax is eliminated and replaced with a transaction oriented tax?  Would the people who converted their traditional IRA’s to Roth IRA’s and paid in hefty sums in taxes to do so get the shaft?  I am willing to bet they would.  It is unlikely that this is going to happen in the next few years, but some people are planning 20, 30 or 40 years out.  There is no telling what the political landscape or the tax system will look like at that time.  (See Tax Diversification on Part IV)

Donna Bordeaux, CPA with Calculated Moves

Creativity and CPAs don’t generally go together.  Most people think of CPAs as nerdy accountants who can’t talk with people.  Well, it’s time to break that stereotype.  Lively, friendly, and knowledgeable can be a part of your relationship with your CPA as demonstrated by Donna and Chad Bordeaux.  They have over 50 years of combined experience as entrepreneurial CPAs.  They’ve owned businesses and helped business owners exceed their wildest dreams.   They have been able to help businesses earn many times more profit than the average business in the same industry and are passionate about helping industries that help families build great memories.