Recs

19

This Smart Money Move Is Worth Waiting For

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Often, you hear writers telling you that you should stop waiting and do something right now. With this piece of advice, though, waiting until next year before you act might be the best move you could possibly make.

On Jan. 1, millions of investors will get an opportunity that many have never had before -- the ability to convert some of their retirement funds into a Roth IRA. Many planners have looked forward to this prospective tax-law change for years, but with the new year just months away, it's beginning to look like some investors may actually get a chance to take advantage of Roth IRAs for the first time.

The change and what it means
Since their introduction in 1998, Roth IRAs have essentially been off-limits to many high-income taxpayers. Single taxpayers having an adjusted income of more than $120,000 and couples earning $176,000 or more in 2009 aren't allowed to make regular contributions to Roth IRAs, and those with adjusted incomes of more than $100,000 aren't eligible to convert existing traditional IRAs into Roths.

But in 2006, the income limit for Roth conversions was abolished for the 2010 tax year and beyond. Of course, at the time, it was highly uncertain whether tax provisions passed under the former administration would survive a change in leadership. Yet although there has been ample time for the new administration and Congress to make tax-law changes, some believe that due to the financial crisis, tax increases are likely off the table until at least 2011. That means that the Roth provisions will likely be allowed to take effect.

Typically, when you convert to a Roth, you have to pay income tax on the amount converted. In 2010, however, the provision allows you to defer that tax, including half of it in your 2011 income and the other half in 2012. That may help keep those who convert from jumping up into a higher tax bracket.

Should you convert?
The big question, of course, is whether it makes sense to convert. Ordinarily, you want to avoid paying tax as long as possible. But many planners point to the fact that doing a Roth conversion essentially allows you to lock in today's tax rates, rather than having to pay tax later on as you withdraw money from your traditional IRAs. If you believe rates will rise, then paying low rates early could be profitable in the long run.

In addition, beaten-down portfolio values actually benefit those who are thinking about converting. For instance, say you own in your IRA 1,000 shares of each of the seven worst Dow performers over the past two years:

Stock

Value, Sept. 4, 2007

Value, Sept. 4, 2009

Tax if Converted in 2007

Tax if Converted Now

Alcoa (NYSE: AA  )

$36,410

$12,180

$12,744

$4,263

American Express (NYSE: AXP  )

$60,770

$32,840

$21,270

$11,494

Bank of America (NYSE: BAC  )

$51,080

$17,090

$17,878

$5,982

Boeing (NYSE: BA  )

$95,920

$49,150

$33,572

$17,203

General Electric (NYSE: GE  )

$39,040

$13,870

$13,664

$4,855

Caterpillar (NYSE: CAT  )

$76,850

$46,110

$26,898

$16,139

Cisco Systems (Nasdaq: CSCO  )

$32,320

$21,840

$11,312

$7,644

Source: Yahoo! Finance. Tax assumes 35% bracket on IRA conversions.

If you converted your entire account now, you'd pay less than $70,000 in taxes, instead of almost $140,000 that you would have paid two years ago. If stock prices stay low into 2010, paying tax on those low values now might save you a bundle down the road.

But there are also some very good reasons why you might not want to convert:

  • Lower income in retirement. Many people -- especially the high-income earners who've been locked out of Roth IRAs until now -- see their taxable income fall in retirement. Often, that translates into lower tax rates on traditional IRA withdrawals during retirement than you'd pay if you converted next year.
  • Retroactive Roth taxes. Some fear that the government may change its mind and find a way to tax Roth IRAs in the future. In that case, those who convert would end up unnecessarily paying tax twice.
  • A big tax bill. If you don't have the extra money outside your traditional IRA to pay the taxes you'd incur by converting, then you should probably steer clear. It's definitely not worth paying taxes and penalties to pay that bill from IRA funds.

The best of both worlds
In general, I'm a big fan of having some of your money in both Roth and traditional IRA or 401(k) accounts. That strategy helps you hedge your bets against whatever your future tax situation may be. So, if you've been completely locked out of Roth IRAs until now, you should definitely consider taking what may be a short-lived opportunity to convert some of your money.

At our Motley Fool Rule Your Retirement service, we'll tell you how a Roth IRA can make a great addition to your retirement portfolio. With investment recommendations and timely advice, you'll figure out your best moves with your money. Get started today with a free 30-day trial.

Fool contributor Dan Caplinger has both Roth and regular retirement accounts, but he's not planning any conversions in the near future. He owns shares of General Electric. The Fool formerly owned shares of American Express, which is currently a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is planning a champagne blowout for New Year's Day 2010.


Read/Post Comments (3) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 08, 2009, at 4:33 PM, TDevils13 wrote:

    So can one open up a Roth IRA with a company like TD Ameritrade and manage it themselves to trade stocks actively but still protected from the tax man?

  • Report this Comment On September 08, 2009, at 7:13 PM, Alwayzwrong wrote:

    Yes, TDevils13. You can open both types of IRAs with E*Trade, TD Ameritrade, Scottrade, etc. THere are only a few limitations (no shorting, for example).

  • Report this Comment On September 11, 2009, at 9:24 PM, lewellen180 wrote:

    Another question - after next year, can I contribute directly to a Roth regardless of my income? It would seem silly not to be able to, as otherwise I could just fund a regular IRA and then immediately convert it ... but sillier things have been in our tax code.

    Just wondering....

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 979903, ~/Articles/ArticleHandler.aspx, 12/22/2014 11:44:33 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

Today's Market

updated 1 hour ago Sponsored by:
DOW 17,959.44 154.64 0.87%
S&P 500 2,078.54 7.89 0.38%
NASD 4,781.42 16.04 0.34%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

12/22/2014 4:02 PM
AA $15.74 Down -0.20 -1.25%
Alcoa, Inc. CAPS Rating: ****
AXP $93.62 Up +0.72 +0.78%
American Express CAPS Rating: ****
BA $128.22 Up +1.99 +1.58%
The Boeing Company CAPS Rating: ****
BAC $17.71 Up +0.09 +0.51%
Bank of America CAPS Rating: ****
CAT $92.32 Up +0.61 +0.67%
Caterpillar, Inc. CAPS Rating: ****
CSCO $28.22 Up +0.45 +1.62%
Cisco Systems CAPS Rating: ****
GE $25.71 Up +0.09 +0.35%
General Electric C… CAPS Rating: ****

Advertisement