Maryland Bar Bulletin
Publications : Bar Bulletin : January 2008

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The Roth IRA has long been viewed by many financial advisors as one of the best ways to save for retirement. The Roth IRA offers many advantages that a traditional IRA or 401(k) does not offer. For starters, although you do not receive a tax deduction for the amount you contribute to a Roth IRA, all qualified distributions from a Roth IRA are tax-free to you upon retirement. If you are over 59-and-a-half years of age and the account has been open for at least five years you may take out any earnings tax-free. Your contributions can be taken any time tax-free. This means that, no matter what the tax rates are or what tax bracket you are in at retirement, you do not pay any taxes on any principal or gains in the account. Similar to a traditional IRA or 401(k), the gains in a Roth IRA grow tax-deferred. Another advantage particular to a Roth IRA is that there is no required minimum distribution age – whereas, you must begin distributions from a traditional IRA no later than age 70-and-a-half or pay a tax penalty. This advantage of the Roth IRA allows for greater flexibility when you are planning for your estate and looking at the possibility of transferring money to your heirs. You can also continue to make contributions past age 70 into a Roth IRA providing you are still working.

Unfortunately, not everyone is eligible to contribute to a Roth IRA. Income limitations have always restricted those who are eligible to contribute to a Roth IRA. Currently, an individual filer who earns an adjusted gross income over $110,000 and joint filers with joint adjusted gross income over $160,000 are not eligible to contribute to a Roth IRA. Now, however, there is a strategy for these individuals to enable them to convert traditional IRAs to Roth IRAs.

Convert to a Roth IRA in 2010

In May 2006, President Bush signed the Tax Increase Prevention and Reconciliation Act of 2005. This Act, along with some other provisions, has made it possible for anyone to convert their traditional IRA assets to a Roth IRA in the year 2010. It effectively allows individuals to contribute to a nondeductible IRA from the 2006 tax year until the year 2010 tax year, and then in 2010 convert all of the proceeds into a Roth IRA – no matter what your current income level. Only gains in the account are taxable in 2010, and a special provision allows those gains to be taxed over a two-year period in 2011 and 2012. Then the entire balance will be received tax-free upon retirement. Consider this hypothetical example: Nicole, age 50, has never made a traditional or Roth IRA contribution. Because her modified adjusted gross income is $200,000, she is ineligible to contribute to a Roth IRA. However, she is eligible to make a nondeductible traditional IRA contribution.

Assume that Nicole makes a $5,000 nondeductible traditional IRA contribution annually for 2006 through 2010 and that her balance after the last contribution is $31,000 ($25,000 regular contributions + $6,000 earnings). In 2010, Nicole converts the entire amount to a Roth IRA. Since all of her contributions were nondeductible, only the earnings portion is subject to federal income tax. She may choose to include the $6,000 conversion income on her 2010 tax return, or spread out the $6,000 over the course of tax years 2011 and 2012.

When Nicole retires, the entire balance will be received tax-free. She will have the flexibility to take distributions or to let the money continue to grow tax deferred in her Roth IRA.

If your income level has previously prohibited you from establishing a Roth IRA, consider making nondeductible contributions to a Traditional IRA and converting it in 2010 to create a source of tax advantaged and flexible retirement savings.

Kelby Gelston is an associate of FranklinMorris, Coordinating Broker for the Bar Associations Insurance Agency, Inc. For more information on the insurance benefits available to MSBA members, visit www.msba.org/departments/membership/baia/franklinmorris.pdf.

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Publications : Bar Bulletin: January 2008

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