Pro's of a Roth IRA Conversion

The Roth IRA is possibly one of the best savings vehicles Congress has given to the American taxpayer. You get to save after-tax dollars, allow them to grow tax-free and take distribution in retirement tax-free.

In 2010 Congress allowed owners of traditional IRA's to make a full or partial conversion to a Roth IRA. Yes, the tax is still due on the money held in your Traditional IRA but once the tax has been paid and the money transferred into the Roth, you are done.

Roth IRA's have many benefits. Today we will address the reasons for converting a Traditional IRA to a Roth. Next week we will cover the reasons when and why you might not/should not convert to a Roth. Note that most reasons are not hard and fast rules. As conditions change, e.g. tax bracket, employment, etc. your decision needs to be reviewed, maybe annually.

Benefits of converting are numerous:
- retirement assets taxable on distribution now move into an account that will grow free of taxes and be distributed free of taxes as well.

- Roth IRA's have no required minimum distribution at age 70 1/2. You may hold a Roth as long as you like and take distributions whenever you like (once you are over 59 1/2 and the account has been opened for 5 years.)

- Distributions, also know as income, pass through as non-events in the federal tax system so payouts do not count as increased income to raise your income tax bracket, Medicare premiums or impose the 3.8% tax on investment income.

- Roth IRA's prove beneficial during the in-between years of retirement before Social Security kicks in.

- Distributions provide necessary income boost without increasing taxes as in filing FAFSA for college aid.

- A Roth conversion helps you better control your tax strategy as once you have paid the tax you no longer worry about tax increases or changing tax policy. Your income/distributions will be tax free.

Be $ Smart - consider the benefits of converting all or part of your Traditional IRA to a Roth IRA. Be sure to consult your tax preparer before making the move.

Minimize your taxes

It makes sense to find ways to reduce your taxable income. One place to start is your portfolio. Your investments generate a certain amount of taxable income each year as witnessed by the number of 1099's you receive in the new year.

If you want to reduce the taxes generated by your portfolio, put the big tax generating investments in your tax-deferred retirement accounts - IRA, Roth IRA and 401k. These include real estate investment trusts (REIT's), taxable bonds and actively managed mutual funds (which usually have high, annual portfolio turnover).

Put stocks and stock indexed mutual funds in your taxable accounts where you will be happy holding them for 12 months or longer. After 12 months, they are taxed as long-term capital gains not as ordinary income, a much lower rate. If you pass this account on to your heirs, they could pay virtually no capital gains tax when they sell.

Be careful as you reconfigure your portfolio. Do it slowly and methodically. If you sell too many investments with gains in any given year in your taxable accounts you may increase your tax obligation and push yourself into a higher tax bracket. Best to consult your account first.

Be $ Smart - re-position your investments to minimize your taxes.

Dual Purpose - Roth IRA

Saving for retirement can be tough while you are trying to build an emergency fund, pay off student loans, car loans and other expenses. But we all know the importance of saving early. The earlier you start saving for retirement, the faster your money will compound and grow.

Here is where a Roth IRA (Individual Retirement Account) can serve two functions. The principal (original money invested) may be withdrawn without penalty and taxes at any time making that money available for emergencies. (It's the earnings - dividends and interest - that would be subject to taxes and penalty if you are under 59 1/2.)

Aim for three months emergency fund in a savings account and three months in your Roth.

How to open a Roth IRA:
You may open an IRA at a bank, credit union, brokerage house (e.g. Fidelity, Vanguard, Merrill Lynch) in person or online.
Questions to ask:
- What is the minimum investment?
- What fees are charged for the account and for transactions?
- What investments are available? Stocks? Bonds? Mutual funds? Exchange Traded Funds (ETF's)?
- How may I arrange for monthly automatic transfer from my savings or checking account?

Your biggest stumbling block may be the required initial deposit. Some firms require only $500 where others $1000 or $3000. Subsequent investments may be as little as $25 or $50. If you are expecting a bonus or a tax return, it may be a good use of that money. Otherwise, keep the emergency money building in your savings account until you reach the required minimum amount then open the Roth.

Using the Roth as part of your emergency fund means taking NO big risks with the money. Choose a very conservative investment for the emergency portion. As your balance grows, start to invest the difference more aggressively.

Keep in mind a Roth IRA is not for everyone. Only those individuals with earned income may contribute. And individuals earning under $112,000 and couples under $178,000 may contribute $5500 (if over 50, $6500). Remember it's not all or nothing. If you cannot contribute the max, contribute some amount.

Be $ smart - use the flexibility of a Roth IRA to your advantage in building your emergency fund.

Taxable - Tax-exempt - Tax-deferred - Tax-free

Clients often ask me to explain the differences among their various accounts. Taxes play an important role in how you invest and how much money you will be able to keep after paying taxes.

The following are simple explanations. For expert tax guidance please speak with your accountant or tax attorney.

Taxable: an account that holds money on which you have already paid taxes - e.g. bank checking or savings accounts or brokerage accounts. These accounts may have stocks, bonds, CD's, etc. Every year you receive a 1099 of all reportable earnings, dividends and interest. You enter these numbers on your tax return and pay taxes accordingly.

Tax-exempt: refers to bonds (loans) issued by municipalities (states, cities, towns, counties). These bonds are exempt from federal taxes. As an incentive to its residents to buy these bonds, which finance local projects, you pay no state taxes on the interest. As a NY resident, if you purchase a NY State bond, it will be double tax exempt as you will pay no state or federal taxes on the interest. However, NY reserves the right to tax the interest earned on other states' bonds.

Tax-deferred: means you pay no taxes now but when you withdraw the money both state and federal taxes are due. IRA, SEP, 401k, 403b all grow tax-deferred. Your 401k or 403b plan from work will take money from your paycheck before deducting taxes, deposit the money into your plan where it will grow tax-deferred (you will not receive a 1099 each year). Taxes will be paid when you start withdrawing money from these accounts later in retirement. The money will be taxed, as your income is taxed, both by the state and the federal government. Hopefully, in retirement you will be in a lower tax bracket and, consequently, pay less in taxes.

Tax-free: refers to a Roth IRA where money grows without paying taxes each year and is distributed without being taxed. Actually, the money contributed to most Roth IRA's is money on which you have already paid taxes; it is the earnings (growth) that are tax-free.

Be $ smart. Know your tax rate. Learn about the impact of taxes on your investments.