The Roth Conversion Opportunity (And Why It’s So Cool)!
Ever heard about this? The idea that you can take your Traditional IRA or previous employer’s 401(k) plan and convert it to a Roth IRA?
If you haven’t, read on. It just might be the best thing since sliced bread, and I’m not kidding.
Heck, even if you have heard about it, read on. You might find it explained here in a better way that you have before, and that would mean I’ve done my good deed for the day.
First, what’s the difference? That sets the stage for why this is such a great idea!
Both the traditional company 401(k) and a Traditional IRA work essentially the same way. In the case of a traditional company 401(k), whatever you contribute to the plan (and there are legal limits) is taken away from your GROSS INCOME (top line of your 1040 form).
In the case of a Traditional IRA, you are responsible for claiming the deduction if you’re allowed to take it (line 32 of the 2009 1040 form). In either case, your ADJUSTED GROSS INCOME (AGI) is reduced – that’s the bottom line of the front page of your 1040 form, and that means that you owe less in taxes…..that year.
The downside? You’ll pay those taxes eventually, as ordinary income, in the year in which you withdraw the money. If you withdraw before age 59 1/2 , you’ll probably have penalties to pay as well, unless you’re withdrawing to meet one of a handful of hardship reasons. That’s okay, though, I mean, you earned the money, and you pay the tax. This is what we call DEFERRING the tax until later, and that works out really well from a math standpoint. (Unless taxes go way, way up later, too.)
Now, in the case of the Roth IRA, the EXACT OPPOSITE is true.
You get absolutely no benefit at all this year from contributing to a Roth. None. Nada. You pay the tax now for crying out loud. Oh, but wait, that means….yep, you don’t pay any tax later. Ever. Now, that’s really cool, especially if tax rates do go up.
The next part of this is that, if it makes sense and you choose to do it, you can CONVERT your old company’s 401(k) and any existing Traditional IRAs into Roth IRAs, and, no surprise if you’ve been following along, not pay any tax on the new Roth IRA balances in the future. Of course, the tradeoff is, as above, that you have to pay the tax NOW in order to make the conversion.
Now, that’s always been true since the Roth was invented, so what’s so cool about 2010?
In 2010, you don’t have to pay the tax.
Huh? Well, okay, you DO still owe the tax, but, you DON’T pay it in 2010 like you normally would. For this year (and who knows what Congress will do tomorrow) but as of this writing, for this year ONLY, you get to do the following:
Pay ½ of the tax due in 2010 as if you earned it in the tax year 2011 (by April 2012) and,
Pay ½ of the tax due in 2010 as if you earned it in the tax year 2012 (by April 2013).
This is HUGE. You might have it already covered by a refund or other deductions, and where you would normally have to worry that you couldn’t pay it, that worry is gone, for this year only.
Your situation is not going to be exactly the same as that of your friend or relative, so don’t do what they say. Even if they’re really smart, they’re not you. Talk to me, and we’ll figure out together what makes the best sense.
Want to know more? Let’s talk, and create a plan that’s right for you and your family.
Visit: http://whattoinvestinnow.com
Email: John@financialideasblog.com
Related posts:
- If I Do The Roth Conversion, Can I Finance The Tax Payment?
- What’s Wrong With Getting A Big Tax Refund?
- Having A Smart Nest Egg!
- How To Handle A 401(K) Rollover To IRA
- What Kind Of Money Should I Put Away Before 2010?
