To Convert or Not to Convert: Consortium of Financial Professionals Offer Points to Ponder When Considering a Roth Conversion

KANSAS CITY, MO, October 15, 2010 (Press-News.org) As the days tick down on 2010, many investors are pondering whether or not to convert a traditional IRA to a Roth IRA? While the benefits of conversion include the ability for after-tax dollars grow tax-deferred and potentially tax-free, qualified distributions being federal income tax-free and no required distributions at age 70 1/2, the downside is that Roth's income limits prevent many investors from opening a Roth account. But at the start of 2010, the income limits for converting traditional, rollover, SEP and SIMPLE IRAs3, and 401(k) or other workplace savings plans with former employers, to a Roth IRA were removed. Before this change, only investors--single or married and filing jointly--with modified adjusted gross incomes of $100,000 and below could convert to a Roth.

Although there are still income limits for contributing to a Roth IRA, today anyone--regardless of their income--can convert retirement assets from a traditional IRA to a Roth IRA. As with so many decisions in life, making the right decision requires moving beyond the general headlines and applying the fine print to your personal situation.

A consortium of advisors who are representatives of and offer securities through Securities America Inc. (www.securitiesamerica.com) offer these six considerations when debating whether or not to convert to a Roth IRA.

Tax diversity makes even more sense in an uncertain tax environment. Pre-tax savings accounts, such as 401(k) accounts, provide obvious benefits for those who will be in a lower tax bracket in retirement. Conversely, after-tax savings accounts, such as a Roth IRA, will be advantageous in the event of higher tax rates. "In an uncertain tax environment, a mix of taxable and non-taxable accounts may be ideal, says Bob Hapanowicz, founder of Pittsburgh-based Hapanowicz & Associates (www.hapanowicz-associates.com).

"Because qualified withdrawals are federal income tax-free, Roth accounts afford investors the flexibility to withdraw their savings in retirement without worrying about an unexpected tax bill."

"You can withdraw enough taxable income from your traditional taxable retirement accounts to keep yourself in a low tax bracket and then supplement your income from your Roth IRA account. If you had to rely on your 401(k) to meet all your retirement expenses it could cause you to be shifted into a higher tax bracket." Hapanowicz stresses that partial conversions, where investors might chose to convert just half of your traditional IRA to a Roth IRA are also a good option.

You don't have to pay conversion taxes all at once. Notably, investors who make conversions in 2010 have the option to spread taxes due over 2011 and 2012. John Egan, CFP and founder of J.M. Egan Wealth Advisors with offices in Madison and Point Pleasant Beach, New Jersey (www.jmegan.com), notes that in promoting the extra time to pay conversion taxes, Uncle Sam fails to mention that the top tax bracket is likely to increase to 39.6 percent from 35 percent in 2011. Explains Egan, "An investor converting a $300,000 traditional IRA to a Roth IRA in 2010, seeking to avoid potentially higher tax rates in 2011 might elect to report the entire $300,000 conversion income on his 2010 tax return. If, however, paying the taxes is difficult in 2010, he could choose to report no income from his Roth conversion in 2010 and instead report $150,000 (one-half) of the Roth IRA conversion in 2011 and $150,000 (the remaining half) of the conversion in 2012."

If you convert and later feel you've made a mistake, you can take a mulligan. Amazingly, investors have until October 15 of the year following a conversion to complete what is called a Roth "re-characterization" and change your account back to a Traditional IRA. To give investors the most flexibility, Brad Bofford, CLU, ChFC and partner at Fairfield, New Jersey-based Financial Principles (www.FinancialPrinciples.com) suggests converting one IRA account into four or five Roth IRAs, each holding a different asset class. "We monitor the accounts' performance and will re-characterize those conversions that decreased in value to get a lower tax cost and leave the accounts that have appreciated to hopefully keep growing," says Bofford. "This strategy affords us the ability to deliver a lot of flexibility from a tax planning standpoints." He adds that converting to several different accounts also enables you to invest differently for each beneficiary.

He cautions that once a re-characterization election is made, funds cannot be converted again until January 1 of the year following the year of conversion, or if later, 30 days from the day you re-characterize. In addition, if an investor re-characterizes a Roth IRA and has used the funds from the initial IRA to pay the taxes, that amount cannot be part of the re-characterization. For example, on a $100,000 withdrawal from a traditional IRA where only $75,000 was rolled into a Roth, only that $75,000 can be re-characterized. Be advised that that this method may subject you to additional fees such as account set up fees, transfer fees, re-characterization fees and additional costs for tax filing if you must file an amended tax return.

A Roth IRA is an effective estate planning tool. For investors who have a significant IRA balance that they don't plan on tapping into to fund retirement, Hapanowicz believes a Roth IRA trumps all other investment vehicles as an effective estate planning tool. "Because there are no mandatory-distribution requirements with a Roth, the account could grow larger than a traditional IRA with mandatory distributions," he explains. "In addition to greater asset growth, your beneficiaries can inherit the account tax-free - and it can continue to grow income-tax-free from federal income taxes over their lifetimes." Secondarily, Hapanowicz notes that the income tax paid at the time of conversion will reduce the amount of the gross estate. "Think of the conversion taxes as prepaying income tax on behalf of your beneficiaries," he says.

The timing of conversion is critical. If personal income varies enough that determining an end-of-year tax bracket becomes difficult, it makes sense to wait until there is a firmer sense of total earning for the year. "If you know your income will be significantly lower in 2011, perhaps due to a planned family leave, for example, you might want to wait to convert next year," adds Egan. "You can take advantage of volatility. If your account values are down, fewer taxes will be due on the conversion."

It's easy to get tripped up by penalties. If IRA funds are used to pay the conversion tax and therefore convert less than the full account value, additional taxes and possibly a 10 percent early-withdrawal penalty could result. To fund the conversion taxes, Bofford suggests that investors consider selling a losing investment in a taxable account to lock in losses to offset current and potential future capital gains and generate cash to pay the taxes on the Roth IRA conversions.

It's also important to manage the Roth's five year rule to avoid an early 10 percent withdrawal penalty "Each converted Roth IRA has its own five year holding period to avoid an early 10 percent withdrawal penalty," explains Bofford. "If you have reached age 59 1/2 at the time of conversion, you can withdraw your converted dollars exempt from the penalty. However, the five year holding period for qualified withdrawals does apply to earnings in your converted Roth account."

About Financial Principles, LLC
Financial Principles understands the importance of planning - whether it's for retirement, saving for college or even charitable giving. Two senior partners, Bradley H. Bofford, CLU, ChFC, and Mike Flower, bring a combination of more than 30 years of financial services experience to their clientele. Both provide comprehensive services and advice in all areas of personal finance, such as estate planning, retirement planning and tax reduction strategies. Believing that a well-informed client is essential for success, they love taking clients from fear to confidence regarding finances, by placing a strong emphasis on educating people about how to prepare for and enjoy a comfortable retirement. Learn more at www.FinancialPrinciples.com.

About J.M. Egan Wealth Advisors, LLC
John M. Egan of J.M. Egan Wealth Advisors, LLC in Madison and Point Pleasant Beach, New Jersey is a financial advisor who specializes in wealth management, retirement planning and independent investment advice. Since beginning work in the financial services industry in 1986, John has worked with hundreds of families, teachers, corporate executives, and small businesses in 15 states to help them design a plan to achieve their financial dreams. He has the comprehensive education and experience to handle all aspects of building and preserving wealth. For more information, visit www.JMEgan.com.

About Hapanowicz & Associates
Since 1987, Hapanowicz & Associates has provided the supervision and management of retirement assets for a variety of clients including: business owners transitioning to liquidity; employees from fortune 500 companies achieving retirement or the next phase of their lives; and plan sponsors who require a high level of personal service for their company's pension, 401(k) or other retirement plans. The firm frequently hosts independent seminars for employee groups from a single company to explain the details of their plan. For more information, visit www.Hapanowicz-Associates.com.

Securities offered through Securities America, Inc. Member FINRA/SIPC. Brad Bofford, John Egan and Bob Hapanowicz, Registered Representatives. Advisory services offered through Securities America Advisors, Inc. and/or J.M. Egan Wealth Advisors, Brad Bofford, Bob Hapanowicz and John Egan, Registered Investment Advisor Representatives. Financial Principles, J.M. Egan Wealth Advisors and Hapanowicz & Associates and the Securities America companies are not affiliated.

Pursuant to IRS Circular 230, Securities America Inc. is providing you with the following notification: The information contained in this article is not intended to (and can not) be used by anyone to avoid IRS penalties. Neither Securities America nor its representatives are permitted to give tax advice. Discussion of tax rules is for general informational purposes only and merely a summary of our understanding and interpretation of some of the current income tax regulations and is not exhaustive; nor does it cover every situation. Consult a qualified professional for tax advice specific to your situation.