Roth IRA restrictions will lift in 2010

November 1, 2009

2010 will be a pivotal year for retirement planning, as it will be the first time taxpayers will be able to convert funds in regular IRAs to Roth IRAs, regardless of their income level.

Key Points

Q: When can I convert my IRA to a Roth IRA?

Stringent income rules also apply to the traditional deductible IRA, where the earnings grow on a tax-deferred basis and the distributions are taxed as ordinary income. The tax law currently allows deductible IRA owners to convert to a Roth IRA, but modified adjusted gross income must not exceed the maximum allowable amount of $100,000, again making most physicians ineligible to convert.

Keep in mind that this provision applies only to conversions actually completed in 2010. For conversions that occur after 2010, all of the taxable portion of the conversion will be taxable in the year the conversion is made. Either way, you are allowed to pay the tax on the conversion from non-retirement account assets, thus avoiding the need to deplete the retirement account.

The decision of whether to convert in 2010 will depend on your thoughts relative to current and future income tax rates. If you expect your tax rate to be the same or higher when you eventually withdraw your money, it may 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, unless the tax law changes again.

The longer you expect your assets to remain within the Roth IRA, the more you can benefit from its federal tax-free growth potential. Roth IRA distributions are tax free if they are deemed to be "qualified distributions," meaning the account owner is age 59½ or older and has held assets in the Roth IRA for a minimum of 5 years.

If you are under that 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 decide, post conversion, to withdraw 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.

Q: What is a Grantor Retained Annuity Trust?

A: In essence, a Grantor Retained Annuity Trust (GRAT) is a trust that provides for a periodic annuity to the grantor for a set term, after which the remainder interest in the trust is left to other individuals, typically the grantor's children.

The amount gifted to the remainder beneficiaries is valued by deducting the present value of the stream of the annuity payments (using the interest rate set forth in the IRA annuity tables) from the market value of the gifted property.

There are a number of design variations of GRATs that may be beneficial depending on your situation.

Financial Tips

Joel M. Blau, CFP, is president and Ronald J. Paprocki, JD, CFP, CHBC, is chief executive officer of MEDIQUS Asset Advisors, Inc. in Chicago. They can be reached at 800-883-8555 or blau@mediqus.com
or paprocki@mediqus.com
.