The Investment Scientist

Posts Tagged ‘roth conversion

Roth Conversion

As 2010 comes to a close, one time sensitive wealth management move affluent individuals and families should consider is converting an existing traditional IRA into a Roth IRA.

It is not a trivial decision, and there is no one-size-fits-all answer. What I hope to accomplish below is to give you a framework to help you make the best decision for you and your family.

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There is one important rule to keep in mind when it comes to converting a traditional IRA to a Roth IRA – you need to pay federal income taxes on any portion of the conversion that you haven’t already paid taxes on.

Example 1

For example, let’s say you started to fund traditional IRAs in 2006 and by 2010 you’ve got $20,000 in your account.  Furthermore, let’s say this account consisted of four years of $4,000 non-deductible contributions – a total of $16,000 in non-deductible contributions and $4,000 in account growth.

In this example, you’d need to pay income taxes on the $4,000 in fund growth when you convert to a Roth IRA.  But the good news is you’ll never have to pay income taxes on this account again.

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Roth-conversion-opportunityStarting from tax year 2010, the Tax Reconciliation Act permits all taxpayers to make Roth IRA conversions, regardless of income level. Previously, taxpayers with a modified adjusted gross income of $100,000 (or more) were not permitted to make Roth IRA conversions.

With a stroke of the pen, many affluent Americans can increase their wealth by 10-20% in their lifetime. If circumstances are right, they may even double their wealth for their family.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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