Have you ever had an idea that brought together two separate and unrelated developments? Last December Congress enacted a new law ( Worker, Retiree and Employer Recover Act of 2008, P.L. 110-458 ) which waived the Required Minimum Distribution (”RMD”) from retirement plans. This means those over age 70½ do not have to take a withdrawal from their IRA or other retirement account in 2009. The unrelated event is the fact that you cannot convert to a Roth IRA in 2009 if your adjusted gross income exceeds $100,000. How can you connect these two unrelated developments and realize benefits?
Let’s say you are fortunate enough to have a retirement nest egg that is sufficiently large so that the annual RMD pushes your annual income over $100,000. Accordingly, you cannot now reap the advantages of a Roth IRA conversion (these are discussed below). The Required Minimum Distribution law was passed so retirees would not have to withdraw money from their lower valued “market invested” accounts and realize massive losses. The Congressional reasoning was “postpone the RMD so market values could increase” (does this economic forecast mean they know something we don’t?). Parenthetically, the market may not recover as our Congressional leader hope – no one knows the future.
When converting qualified retirement money to Roth IRA, the income taxes must be paid during the year of conversion. As I mentioned in my retirement blog, converting retirement money to a Roth IRA in 2009 makes a great deal of sense for many retirees because:
- Investments have shrunk in value and income taxes will be lower now than they will be if the market rises and values recover;
- No RMD is required from a Roth – it does not have to be used during the lifetime of the owner or the spouse of the owner;
- If passed to an heir, principal and earnings remains tax-free but must be withdrawn over the expected lifetime of the beneficiary;
- If future tax rates are expected to increase, it makes sense to pay the tax now while tax rates are lower;
- Withdrawals from a Roth IRA after conversion do not count as income in determining the taxes on your Social Security benefits;
- The $100,000 income limit is slated to be suspended in 2010 but this could be changed before and the opportunity lost forever;
- The RMD waiver of 2009 may be for one year only;
- If circumstances change you can undo the Roth conversion before filing your 2009 income taxes (as late as October 15, 2010) and avoid taxes on the conversion.
Accordingly, if the waiver of the RMD in 2009 allows you to limit your income to no more than $100,000, it might make sense for you to convert your retirement money to a Roth IRA.
Whether or not a Roth IRA conversion makes sense will depend on your circumstances. A Roth conversion may not be right if you’re in a low tax bracket, pay few or no taxes on your Social Security benefits, have no aspirations of leaving a legacy to your heirs, or will need your money early in retirement. On the other hand a Roth conversion does make sense if your tax bracket is currently high, you expect future tax rates to rise, you’re paying taxes on SS benefits, you don’t need the RMD money, you’d like to leave a tax-free legacy to your loved ones, and you will not have more than $100,000 in 2009 income. The best way to learn the pros and cons of Roth IRA conversion is to (a) learn as much as possible on your own and (b) work with your financial advisor to determine how much of your retirement money should be converted to a Roth. The “window of opportunity” is going to be short-lived, so don’t procrastinate.
Shelby J. Smith, Ph.D.
February 2009
TheRetirementPros.com
Related Topics by Dr. Shelby Smith: You, Taxes and Retirement (eReport PDF & Video), Guide to Social Security & a Better Retirement (eReport PDF & 10min Video), Fixed Annuities: A Good Option for Bad Times (Video Seminar).
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