Our clients, from Boston and all over Massachusetts, ask us about IRAs, Roth IRAs and the new rules about conversion.
First, an IRA is an Individual Retirement Account in which if you have earned income, you may contribute up to $5,000 in 2009; however, if you are 50 or over, you may add an additional $1,000. You must have earned income of the amount you are contributing. The good news is that you can deduct from your taxable income the amount you contribute. The bad news is that at the time of withdrawal, you must declare the amount you withdraw as income. Further, when you reach age 70.5, you must begin withdrawals (and pay the taxes) per an IRS schedule; and any monies left when you die are taxable to your estate.
This brings us to the Roth IRA. It has the same rules as the IRA…with a twist: you cannot deduct the amount of the contribution in the year you contribute, but when you “retire” and withdraw, you will pay zero taxes. The trick is to know when your tax bracket is higher – now or when you retire. It gets even better, however, because you don’t ever have to make any withdrawals and you can leave the monies to your heirs tax free.
Third, Congress has added another twist which is especially applicable for year end tax planning: CONVERSION from an IRA to a Roth IRA. In 2010, you can convert your IRA to a Roth IRA, pay the taxes, and have your investments grow tax free. In addition, you can split the tax payment into two years – 2010 taxes and 2011 taxes. For 2009, you can still undertake the conversation, but you can’t split the tax payments into two years and your taxable income must be below $100,000.