Feature

Roth IRAs: Wealthy savers eye a switcheroo

Thanks to a federal law just coming into effect, taxpayers earning more than $100,000 can take advantage of a Roth IRA.

Next year high earners may be surprisingly eager to incur a larger tax bill, said Pamela Yip in The Dallas Morning News. But only because they want to avoid paying even higher taxes in the future. The way they could manage this feat is by converting the funds in their tax-deferred IRA accounts into Roth IRAs, whose funds aren’t taxed upon withdrawal. For years, the Roth IRA “has been one of the best tax breaks around”—but it’s only been available to taxpayers with less than $100,000 in annual adjusted gross income. “That will change next year,” thanks to a federal law just coming into effect. Switching funds into a Roth IRA means paying income taxes immediately on the entire converted amount, so the initial cost may be “substantial.” But so are the benefits.

Just because high-income investors will soon have the option of converting to a Roth doesn’t mean they should, said Jeff Benjamin in Investment News. Tax experts are “working overtime on Roth conversion number-crunching scenarios” for their wealthy clients, but the “wild card” is predicting what will happen to income tax rates in the future. Taxes for many high earners could go up as soon as 2010. “Lots and lots of people are ­talking about doing Roth conversions next year, blindly thinking they’ll still be in a 35 percent tax bracket,” said Herbert Daroff, a tax attorney with Baystate ­Financial Planning in Boston. “But with the conversion income and potential tax increases, you could end up in a 50 percent or 60 percent tax bracket next year.”

In 2010 only, taxpayers can choose to spread out their tax bill, said Karin Price Mueller in the Newark, N.J., Star-Ledger. Doing so might seem like a no-brainer, but it could come back to bite you—after all, tax rates could go even higher in 2011. The decision of whether to convert “depends very much on your personal circumstances.” Make sure you can afford to pay the taxes out of savings—without dipping into retirement funds—and realize that you can’t predict future tax increases or other economic factors. Ultimately, no matter what you decide, it could make hardly any difference in your lifetime tax bill. “If you assume tax rates, growth rates, and your income remain the same in retirement on either a Roth or traditional IRA account, there is no real advantage” to converting.

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