With a deductible IRA, the earnings grow on a tax-deferred basis, and the distributions are taxed as ordinary income.
A Many physicians would like nothing better than to take advantage of the tax-free buildup and tax-free withdrawals associated with a Roth IRA, but are ineligible to do so because of the income restrictions imposed by the IRS. With the 2007 adjusted gross income (AGI) phase-out occurring between $156,000 and $166,000 for joint filers and $99,000 to $114,000 for single filers, physicians who are not participants in qualified retirement plans are left with a deductible IRA as their sole retirement funding option.
The decision of whether to convert in 2010 will center on your thoughts relative to current and future income tax rates. If you believe that your tax rate will be the same or higher when you eventually withdraw your money, it may actually make sense to pay the tax liability associated with the conversion in exchange for the opportunity for federal tax-free growth and future federal tax-free distributions. While a conversion to a Roth IRA requires you to include the assets you're converting among your taxable income, it also enables you to avoid federal taxes on future IRA earnings and withdrawals. Obviously, the longer you expect your assets to remain within the Roth IRA, the more you can benefit from its federal tax-free growth potential.
If you are under the magic age of 59½, distributions from IRAs are subject to a 10% early withdrawal penalty. This penalty is waived for the purpose of the conversion. If you then decide, post conversion, to withdraw funds from your Roth IRA and are under age 59½, you would still be subject to the 10% early withdrawal penalty.
On the other side of the age spectrum are the rules dealing with the required minimum distributions from a traditional IRA, which must begin by age 70½. Roth IRAs have no withdrawal requirements. Thus, taxpayers can allow their money to stay in the Roth IRA much longer, with the hope of generating additional tax-free income. This is certainly a great benefit for retirees with sufficient non-retirement assets that they do not need to draw on their retirement savings to finance their retirement standard of living.
If you are considering implementing a conversion to a Roth IRA in 2010, it's never too early to start discussing with your tax adviser the specific advantages and disadvantages as they relate to your own situation.
Q I have malpractice insurance, but my insurance agent is recommending that I purchase an umbrella insurance policy. Is this really necessary?