Legislation passed nearly four years ago will soon allow a new group of American savers to have access to the Roth Individual Retirement Account (IRA). With a Roth IRA, participants are taxed on their contributions, but they can make tax-free withdrawals once they hit age 59 1/2 (although they must have held the account for at least five years).
Contributions to a Roth IRA are limited as follows:
2009 Contribution and Deduction Limits – Amount of Roth IRA Contributions That You Can Make For 2009
|
| |
This table shows whether your contribution to a Roth IRA is affected by the amount of your modified AGI as computed for Roth IRA purpose.
| If You Have Taxable Compensation and Your Filing Status Is… |
And Your Modified AGI Is… |
Then… |
| married filing jointly or qualifying widow(er) |
Less than $166,000 |
you can contribute up to the limit. |
| at least $166,000 but less than $176,000 |
the amount you can contribute is reduced. |
| $176,000 or more |
you cannot contribute to a Roth IRA. |
| married filing separately and you lived with your spouse at any time during the year |
zero (-0-) |
you can contribute up to the limit. |
| more than zero (-0-) but less than $10,000 |
the amount you can contribute is reduced. |
| $10,000 or more |
you cannot contribute to a Roth IRA. |
| single, head of household, or married filing separately and you did not live with your spouse at any time during the year |
less than $105,000 |
you can contribute up to the limit. |
| at least $105,000 but less than $120,000 |
the amount you can contribute is reduced. |
| $120,000 or more |
you cannot contribute to a Roth IRA. |
|
|
[SOURCE: Internal Revenue Service website, www.irs.gov]
Not only are contributions to Roth IRAs limited, but to convert a retirement plan to a Roth IRA, only individuals with a modified adjusted gross income (MAGI) of less than $100,000 are eligible. This limitation has shut out many individuals who might otherwise find a Roth IRA to be advantageous to their financial planning. Thanks to a 2005 tax law, though, a window for conversions is about to open. Beginning in January 2010, most individuals who have a MAGI of more than $100,000 will be able to convert a portion of their retirement savings from their traditional IRA or 401(k) into a Roth IRA.
For tax years beginning after Dec. 31, 2009, the $100,000 MAGI limit on the conversion of a traditional IRA to a Roth IRA is eliminated (Internal Revenue Code Sec. 408A(c), as amended by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA)). Under TIPRA, the amount rolled over is included in the individual’s income as a distribution, but the 10-percent penalty for early withdrawals does not apply. Individuals who convert from a traditional IRA to a Roth IRA in 2010 have the option to recognize the conversion in income over a two-year period in 2011 and 2012 or elect to recognize the income in full in 2010.
Whether one should take advantage of the new Roth IRA conversion rules is particular to one’s financial circumstances. However, the following are a few general examples of why it may be a good idea:
Take advantage of losses in an investment portfolio
Seeing your traditional IRA or 401(k) shrink by 30 percent is disconcerting to say the least, but by converting a portion of these accounts to a Roth IRA now, one will pay less in taxes. Thus, one may make some lemonade out of that lemon, and grow the remaining amount tax-free.
When you convert part of your IRA or 401(k) balances to a Roth IRA, you pay taxes on the amount being converted. Because the account balances are smaller than they were, one’s taxable balance is likely to be considerably lower today than before the onset of the financial crisis.
Future higher tax rates
The federal deficit is growing to epic proportions thanks to government fiscal stimulus initiatives and financial and auto industry bailouts. Although the deficit itself can be financed through Treasury auctions and other government debt instruments, the interest owed must be paid in order for the U.S. to keep its AAA rating. As we all know, the government’s primary source of income is the taxpayer. Thus, tax rates will almost surely increase sometime in the future, and they will likely remain elevated for some time as the U.S. struggles to service and, hopefully, pay down its debt.
For those considering a Roth IRA conversion, there is no time to waste from a tax perspective, especially for younger savers or those whose income has been drastically reduced due to the poor economy and are in the 10-percent or 15-percent tax bracket. In a year or two, the same person may be in a higher tax bracket because of a new job or salary increase, so it’s best to take advantage of low tax rates now.
Also, for those who are eligible to contribute to a Roth IRA there are sound tax reasons choosing the after-tax Roth IRA versus the tax-deferred traditional IRA. The Internal Revenue Code makes no distinction between the limits on making contributions to Roth IRA and on making deductible contributions to traditional IRAs. In 2009, for instance, you can put a total of $5,000 into IRAs of both kinds ($6,000 if you’re 50 or older). Over time, Roth IRAs return more than traditional IRAs.
Here’s an example: let’s say you put $5,000 into a Roth IRA this year and leave it untouched for 30 years. If it grows at 6 percent a year, you would end up with $28,717, tax free. To get that much from a traditional IRA in 30 years at 6 percent, you would have to invest $6,944 initially, let it grow and then pay income tax on the total (assuming you’re in the 28 percent federal tax bracket). However, your contribution is limited to $5,000, so there is no comparison.
Now, with a traditional IRA, you do get an up-front deduction. In this case, that would be worth $1,400. But even if you invest your deduction in a taxable account for 30 years, the total will still fall short of the return in the Roth IRA. It may seem against conventional wisdom that after-tax dollars make for a better tax shield, but the combination of equal contribution limits and tax-free withdrawals gives the Roth an edge. That edge increases if tax rates increase in the future.
Estate-planning advantages
Since you can accumulate large sums in Roth IRAs without having to worry about taking distributions, they make excellent vehicles for estate planning. You can pass a Roth IRA to your heirs and they will never have to pay taxes on the amounts they withdraw. They will have to make mandatory distributions according to IRS timetables but can stretch out drawdowns over their lifetimes, which makes Roth IRAs a particularly good asset to leave to grandchildren.
When a traditional IRA or 401(k) is passed on to a beneficiary, the beneficiary has to pay taxes on whatever is left in that nest egg based on their own tax bracket—not the tax bracket of the original account holder. With a Roth IRA, the beneficiary acquires the account without having to pay taxes on the cash that’s left, because the original holder had already paid taxes on the contributions.
For more information on the current rules for Roth IRA conversions, please click on the following link to the Internal Revenue Service’s website: Roth IRA Conversion Rules (Publication 590).
I will issue an update when the IRS releases guidance on the 2010 conversion rules.
Gregg D. Killoren
victoria1014
A Stronger U.S. Dollar in 2010?
The sickly U.S. dollar will find renewed health and vigor, beginning in 2010, according to an analysis published by three economists. Christian Broda, Professor at the University of Chicago, and Head of International Research at Barclays Capital, Piero Ghezzi, Managing Director, Head of Economics and Emerging Markets Research, Barclays Capital, and Eduardo Levy-Yeyati, Director, Head of Emerging Markets Strategy, Barclays Capital have jointly authored research showing that the ongoing decline in the value of the U.S. dollar is likely to be broken next year.
This year stock markets around the world, including the Dow Jones Industrial Average, Nasdaq and S&P 500, have rallied as the value of the U.S. dollar has declined against other currencies. Most the dollar’s fall can be explained by the loose Federal Reserve monetary policy, which includes interest rates of near zero and multiple government-sponsored programs to generate liquidity in credit markets (i.e. printing money to keep credit flowing). But as Bespoke Investment Group LLC points out, a falling dollar and a rising stock market is an anomaly in history. The following is snippet of Bespoke’s analysis:
When the credit crisis hit with full force in the fall of 2008, the US dollar rose sharply, while US interest rates fell sharply. The three economists had noted in previous research “the puzzling response of the dollar and US rates during the panic of the fourth quarter of 2008—stronger dollar and lower rates—would be temporary and that the return of risk appetite and structural aspects of the new global balance—smaller gross capital flows and the savings drain resulting from global fiscal policies—would steepen rates and weaken the dollar.”
The authors believe that both U.S. monetary and fiscal policy will join forces to push long-term rates higher when quantitative easing ends. The end of quantitative easing in 2010 and the start of the tightening cycle in the U.S.—both supportive forces for the dollar—should also compensate dollar-negative fiscal considerations. Thus, contrary to the popular view of a continuously weaker dollar, the phasing out of quantitative easing implies that the dollar may strengthen in 2010 relative to other currencies.
If that is true, many stock market analysts currently believe that a stronger dollar, especially one brought on by central bank exit strategies, would destroy the recent market rally. However, viewing the market from Bespoke’s perspective, such a change would likely be positive for the market in the long run. One should consider too that the Federal Reserve has stated that it will keep rates near zero for as long as necessary to get the economy going again. If the Fed lifts rates and exits other monetary programs, this would be a strong signal that the economy can stand, walk and perhaps run on its own two feet.
Please click on the following link to view the economists’ research at Voxeu.com: The new global balance – Part II: Higher rates rather than weaker dollar in 2010
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Posted in Economy, Federal Reserve Board, Investing, Market Commentary, Personal Finance, Stocks
Tagged Currency, Dollar, Economy, Federal Reserve, Investing, Market Commentary, Personal Finance