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This year, thousands of investors will be handed the keys to a turbo-charged vehicle for retirement and estate planning. Investors are now allowed to convert a traditional IRA to a Roth IRA regardless of the investor’s income. This change in the tax code, which began on January 1, 2010, presents a powerful opportunity for you to ignite your retirement income and ensure your legacy for future generations.

If you are like most investors, you have been making tax-deductible contributions to an IRA, 401(k), or other tax-advantaged retirement account throughout your career. But if your modified adjusted gross income was more than $100,000, you were not permitted to convert those accounts to a Roth IRA and benefit from the tax-free growth within those accounts. That income limitation was eliminated after 2009, and that could be very, very good news for you.

Do You Want Your Tax Break Now or Later?

Traditional IRAs provide up-front tax break in the form of deductible contributions, but withdrawals from these accounts are fully taxable. That means even the growth of the investments are treated as ordinary income upon withdrawal. Roth IRAs, on the other hand, do not provide an up-front tax break, but qualified distributions during retirement, including the growth of the investments, are 100% tax-free. Another benefit of a Roth IRA is that the account owner does not have to begin taking required minimum distributions from the account after reaching age 70 1/2. 

There’s no such thing as a free lunch, and that is certainly the case with Roth IRA conversions. Upon converting to a Roth IRA, the account owner must pay income tax on the amount converted. An investor in the 28% tax bracket would owe $280,000 on the conversion of a $1 million IRA. Although this upfront tax bill can be quite steep, the prospects of tax-free growth and estate-planning benefits make a Roth conversion more than worth it for many investors.

Another nuance in the tax code can make paying this tax bill even easier. For conversions completed in 2010 only, the IRS will allow the recognition of income to be split between the 2011 and 2012 tax years. Accountants like to say “taxes deferred are taxes saved,” so the opportunity to defer paying taxes up to 34 months certainly looks appealing.

An investor who converts a $1 million IRA to a Roth IRA in January 2010 could elect to pay half of the tax bill as late as October 15, 2011 and the other half on October 15, 2012 (assuming the taxpayer applies for the six-month tax-filing extension in both years). Spreading the payment of the tax bill over 34 months will make it much easier for the account owner to pay the conversion tax without liquidating assets in the IRA.

Deferring the taxes to 2011 and 2012 is not a no-brainer, however, because the top marginal tax rate is slated to increase from 35% to 39.5% after 2010.

Cementing Your Legacy

If you dream of creating an enduring financial legacy for younger generations, then a Roth IRA conversion can be a powerful tool to help you realize that dream. By converting to a Roth IRA, you are effectively pre-paying income taxes for your heirs. The income taxes due upon the conversion are a tax-free gift to your heirs and the Roth IRA essentially becomes a tax-free annuity for your heirs to enjoy throughout their lives. Your heirs will have the freedom to access these funds whenever they want without concern about paying taxes. What a tremendous way to strengthen your legacy!

Be Aggressive and Take a Mulligan If Necessary

Given the unpredictability of financial markets, there is no guarantee that a Roth conversion will end up saving taxes. But the opportunity to undo a Roth conversion within a limited time frame helps mitigate the risk of a conversion backfiring, giving investors even more incentive to be aggressive with Roth conversions.

A market downturn soon after a Roth conversion would undermine the potential tax benefits of a conversion. Consider an investor—let’s call him Ralph—who chose to convert to a Roth IRA in September 2008:

At the time of the conversion, Ralph’s IRA was worth $100,000, so assuming he is in the 28% tax bracket, Ralph would owe $28,000 income tax on the conversion. As we know, the ensuing six months were disastrous for investors as the credit crisis and ensuing recession caused equity markets to fall by about 40%. As a result Ralph owed $28,000 tax on an account that by March 2009 was worth only $60,000.

Luckily, the IRS lets Ralph and all investors take a mulligan in these situations. Instead of saving a few strokes on the golf course, this type of mulligan can result in thousands of dollars of tax savings.

An investor who performs a Roth conversion has until the tax filing date the following year to recharacterize, or undo, a Roth conversion. This means Ralph would have been able to recharacterize his converted Roth IRA back to a traditional IRA any time up to April 15, 2009 (or October 15, 2009 if he applied for a six-month extension on his taxes). Because the Roth conversion has been undone, Ralph will not owe the $28,000 income taxes created by the original conversion. 

After a Roth conversion has been recharacterized back to a traditional IRA, there is a 30-day waiting period before another Roth conversion can be performed. If Ralph had recharacterized his account as a traditional IRA on March 31, 2009, he would have to wait until May 1, 2009, before he could perform another Roth conversion. At this point Ralph’s IRA had recouped some of its losses and was now worth $70,000. Converting to a Roth IRA now would result in a $19,600 tax bill compared with the $28,000 tax bill due on the original Roth conversion. That is one valuable mulligan!

Of course, it is impossible to know how markets will behave in the months following a Roth conversion, and that is the beauty of the recharacterization option. It gives investors up to October 15 of the following year to monitor the account’s performance and decide whether recharacterizing the conversion makes sense. This opportunity to make decisions based on up to 22 months of hindsight is rarely—if ever—available in the world of investing.

Investors can seize this rare opportunity by creating separate IRAs, each with distinct asset classes, investment strategies, or risk profiles. After converting each account to a Roth IRA in Year 1, the investor then has until October 15 of Year 2 to monitor the performance of each account. The best-performing accounts would remain as Roth accounts, but the worst-performing accounts would be recharacterized as traditional IRAs. For the recharacterized accounts, the investor could then attempt another Roth conversion after 30 days and hope to catch a market upswing for those accounts.

 Roth Conversions, Powerful Opportunities

Whether you aspire to turbo-charge your retirement income or create an enduring legacy for your heirs to enjoy, converting a traditional IRA to a Roth IRA in 2010 and beyond presents unprecedented opportunities for investors. Thanks to the ability to recharacterize these conversions, Roth conversions present a low-risk and potentially high-reward proposition. And they could make 2010 a great year for investors.  

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Fort Worth Personal Injury Law Firm www.jhbma.com The firm’s lawyers are involved as lead counsel in major litigation throughout Texas and the nation. JHBMA represents individuals and families in cases involving serious personal injury and / or wrongful death. In pursuit of justice for its clients, JHBMA has prosecuted cases resulting from negligence, product liability, medical malpractice, and defective / harmful drugs. The firm also has expertise in representing individuals and businesses in complex litigation Automobile Accidents Large Truck / Tractor Trailor Accidents Oil / Gas Field Accidents Motorcycle Accidents Bus Accidents Medical Malpractice Nursing Home Neglect Electrocution Injuries Spinal Cord / Brain Injuries Railroad / Train Accidents (Including FELA Claims) Workplace / On-the-Job Injuries Burn Injuries Wrongful Death Cases Defective Drugs Defective Tires Aviation Accidents / Defects ATV Accidents Personal Watercraft / Boat Defects Airbag Deployment Defects Seat Belt Injuries Contract and Business Torts Oil and Gas Litigation Securities Fraud Consumer Fraud / Deceptive Trade Practices Business Litigation & Partnership Disputes
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Cigna / LINA (Life Insurance Company of North America) is one of the world’s largest Group ERISA long-term disability insurance companies. In this episode disability insurance attorneys Gregory Dell Stephen Jessup and Cesar Gavidia of Attorneys Dell & Schaefer discuss CIGNA and their handling of long term disability insurance claims. Our website is visited by thousands every month and we invite you to share the experiences you have had with CIGNA / LINA at: www.diattorney.com If you are in need of assistance regarding your long term disability claim please contact us for a free consultation at www.diattorney.com
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