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Roth IRA's Basics

| February 01, 2011
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By Gregg Shaw

Roth IRA’s – Clients are Asking….

At Chatham Wealth Management, clients continue to seek guidance on Roth IRA’s.   Should I contribute to an IRA?  Should I convert to an IRA?  Can I convert in 2011 and pay the tax over two years?   Still, many clients are confused.  Now that we’re in the 2011 tax season, here are some most frequently asked questions about Roth IRA’s. 

Can I contribute to a Roth IRA?  A client recently TOLD me he planned to open and contribute to a Roth IRA for his 17 year old daughter.   His daughter, a senior in high school had NO job/earned income.   Suffice to say, she did not qualify for contributing to a Roth IRA.  

2011 Roth IRA income Limits

MFJ – $169,000 or less – maximum contribution allowed ($5,000 under 50; $6,000 over 50).
$169,001 - $179,000 – partial contribution allowed due to phase-out limits
$$179,001 – contribution NOT allowed no matter what age

Single/HH/MFS - $107,000 or less - maximum contribution allowed ($5K under 50; $6K over 50).
$107,001 - $122,000 – partial contribution allowed due to phase-out limits
$122,001 – contribution NOT allowed no matter what age

Is there still an income limit on who can CONVERT to a Roth?  Many believe the income limits were repealed for just one year (2010).   Income limits disappear forever starting in 2010.  Even Bill Gates can convert to a Roth!

 How is the tax paid under the two-year Roth conversion payout provision?  Not only are clients confused but, so too, are many financial advisors about this question.   It’s NOT the tax that is spread over two years; it’s the Roth conversion income.  Therefore, the ultimate tax burden will depend on a number of items including your client’s income, deductions, credits and exemptions.  The conversion amount CAN push a taxpayer in a higher tax bracket. 

Should I pay the tax in lump sum or over a two year period IF I converted in 2010?  According to Ed Slott, a nationally recognized IRA distribution expert, since the tax rates are extended to 2011 and 2012, than (all other factors being equal) clients should take the two-year deal since there is no increased tax cost and they get to hold on to their money longer (earn more interest) before they have to pay the tax bill. The only reason to opt out of the two-year deal and include all the conversion income in 2010 if client had high deductions or business losses to absorb conversion income and lower the tax. 

Can clients include some of the 2010 Roth conversion income in 2010, some in 2011 and the rest in 2012?  No!  Either the Roth conversion income is reported under the two-year deal, half in 2011 and half in 2012, or the entire amount is reported in 2010.  However, if your clients are married and each have an IRA or plan funds they converted in 2010, each spouse can elect a different method.  This is one way to simulate a three-year payout. 

If clients decide to undo (recharacterize) their 2010 Roth conversions in 2011, how soon can they reconvert those funds to a Roth IRA?  They must wait until the calendar year after the conversion or more than 30 days after the recharacterization, whichever is LATER.

Can clients do a partial recharacterization?   Yes!  In fact, one strategy to take advantage of is to establish several Roth IRA’s and convert different asset classes into separate Roth IRA’s.  For example, one can open three Roth IRA’s and move their bonds into one, domestic equities into another and International equities into the remaining Roth IRA.  If two out of the three funds go up, an investor may recharacterize the only Roth than declined in value.

Deciding whether to contribute or convert, recharacterize or pay the tax over a two-year period isn’t necessarily a straightforward decision.  At Chatham Wealth Management, we can act as their quarterback as well as work closely with accountants to help clients make an informed decision.

As always, thank you for the continued trust you’ve placed in us and look forward to hearing from you soon. 

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