Counterpoint — A Commentary of Jurika, Mills & Keifer LLC
March 2010

To Roth or Not to Roth…

…That is the question.

Much has been written about Roth IRAs and how 2010 is a great time to convert your traditional IRAs over to a Roth IRA.

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Although there are circumstances where this makes a lot of sense, the decision is not as simple as some suggest. It really depends on a few key issues that we discuss below. But first, a little background…

Traditional versus Roth IRAs (Individual Retirement Accounts)

There are two forms of IRA accounts: traditional (which consist of individual IRA accounts and other forms such as SEP and SIMPLE-IRAs) and Roth IRAs.

While both forms of IRA accounts allow money to grow tax-free as long as it is inside the account, there are two major differences between the two.  The first difference has to do with the timing of when you pay taxes.  A traditional IRA allows you to deduct the funds you contribute from your taxable income today - offering an immediate tax benefit - in exchange for paying tax on distributions from your IRA in the future.  Conversely, a Roth IRA does not allow you to deduct your contributions from current income but all future withdrawals are tax free.

So if you are currently in a low tax bracket or believe that your future income rates will be higher, the Roth IRA can be beneficial.

On the other hand, if you believe that your income tax bracket during retirement years will be signifancly lower than it is today, you are probably better off staying with a traditional IRA.

The second difference is that the Roth account has no mandatory withdrawal requirement and therefore the money can remain in the account and appreciate  tax-free for as long as you want. You can even pass the account onto your heirs.  With traditional IRA accounts, you must make certain mandatory withdrawals beginning in the year you turn 70 1/2 years old. 

So if you believe you will have little or no need to withdraw funds from your retirement accounts, especially around the time you turn 70 1/2 years old, then a Roth could be the best choice for you.

Roth Conversion Restrictions Lifted

The big change this year is that the income restriction has been lifted from the Roth IRA conversion rules. Prior to the start of this year, if you made over $100,000 you could not open a Roth IRA account. That restriction has been eliminated this year. Since January 1, 2010, everyone is eligible to convert their traditional IRA accounts (and some qualifying company-sponsored retirement accounts such as 401(k) plans) over to a Roth IRA, if they so choose. There are still limitations however on whether you can contribute new money into a Roth IRA.

Converting to a Roth IRA does mean that you will have to pay income taxes on the amount being converted. You should have this money available and not use funds in the IRA account to pay the taxes (if you are under 59 1/2 years old, this would be deemed an early withdrawal and subject to a 10% penalty). For example, if you convert or rollover $100,000 from a traditional IRA into a Roth IRA, you will need to include this $100,000 amount as ordinary income on your tax returns and pay ordinary income taxes on this amount. However, for all conversions done in 2010 (and only in 2010), the IRS is giving tax-payers the option to split this income recognition evenly between your 2011 and 2012 tax returns. This gives you the option to delay the tax burden and reduce the current tax cost. In addition, it may prevent you from jumping up tax brackets if the full amount were included in one year.

Another consideration is if you believe your assets will become subject to estate taxes (currently that means assets greater than $1.0 million, but please see below for further information), then a conversion may be beneficial, but this really depends on the size and structure of your estate relative to prevailing tax laws.

Key Issues In Deciding Whether a Roth Conversion is Right For You.

You should consider converting to a Roth IRA if any of these situations apply to you:

  1. You are currently or temporarily in a low tax bracket,
  2. You expect your future tax rates to be higher than your current rate,
  3. You do not anticipate needing your retirement funds during your lifetime.

You are likely better off keeping your traditional IRA as-is under the following circumstances:

  1. None of the above situations apply to you,
  2. You do not have the cash available to pay the taxes on the converted amount (this year or spread evenly into 2011 and 2012), or
  3. You think you’ll likely retire to a location that has a much lower state tax rate (effectively meaning your future total tax rate is likely to be lower than your current rate).

In many cases, the answer is not so clear cut, for example if your tax rate is unlikely to change dramatically and if you may need to tap the Roth IRA, but not until well after you would be required to start tapping into a traditional IRA. Nor is the answer necessarily all-or-nothing.  It may make sense to convert some, but not all of your traditional IRAs.

Much depends on your own unique circumstances and should be evaluated carefully, with an objective of maximizing your long-term after-tax assets.

If you are unclear on what to do, we recommend that you sit down with your financial advisor or CPA and do some basic financial modeling to determine the best course of action.

We are happy to help walk you through the analysis of your own individual circumstances.

Tax Law Changes Are Likely In Our Future

Finally, in doing your analysis, you should be aware of the pending changes in the Federal tax rules that will likely affect you. The first is that many current tax breaks are set to expire this year. These include: reduced tax rates on dividends and long-term capital gains as well as lowered income tax rates.

If no legislation is passed to extend these lower rates, they will revert to higher rates at the end of 2010.

Additionally, the estate tax rules are in a state of flux. The exemption (or the amount of total assets that an estate could pass tax-free) was $3.5 million last year. This exemption expired at the end of last year and so the estate tax is currently zero. The current law calls for an exemption of $1 million to be re-implemented in 2011 (meaning $1 million can pass tax-free and all amounts above that will be taxed).

In all likelihood there will be a change to these laws by the end of this year, especially given the Federal Government’s growing need for tax revenue. At this point in time it is hard to tell exactly how all this will play out, but we will watch these issues and notify you of any changes in the future.

In the meantime, if you have any questions or would like some help in thinking through these issues to determine what is in your best interest, please do not hesitate to contact us.

Jurika, Mills & Keifer

Important Disclosures

Opinions expressed are those of Jurika, Mills & Keifer, LLC, and are subject to change.

Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

All views and opinions in this letter are of a general nature and should not be construed or relied upon as specific investment or tax advice for any specific person, persons, or entity. Each person’s circumstances are unique and all investment, tax, and legal decisions should be made by the individual in consultation with his or her financial advisor, accountant and attorney.

All tax-related guidance contained in this letter is of a general nature and is not intended to represent specific tax advice for any individual. Jurika, Mills & Keifer is not a Certified Public Accountant and all tax advice contained in this letter should be verified by a CPA.

This communication is neither an offer to sell nor the solicitation of an offer to buy a security or advisory services, which can only be made by the appropriate offering document.