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As Roth IRAs Turn 10, They Gain New Attention

Direct Rollovers from Traditional 401(k)s Now Allowed; Income Limits on Traditional to Roth IRA Conversions Eliminated as of 2010  

(RIVERWOODS, ILL., January 2008) – Individuals who haven’t given much thought to Roth IRAs over the past decade may want to reconsider now that it is becoming easier to use these IRAs for retirement savings, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and pension information, software and services (CCHGroup.com). Starting in 2008, direct rollovers from qualified retirement plans, such as 401(k) plans, to Roth IRAs will be allowed and, starting in 2010, the $100,000 adjusted gross income (AGI) limit that is precluding many individuals from converting traditional IRAs to Roth IRAs will be lifted; in the near-term, this also is creating added interest in contributing to non-deductible IRAs among higher income individuals.

“While Roth IRAs don’t make sense for everyone, they can be an important part of many Americans’ retirement savings and estate planning, helping them to build wealth that can be distributed tax free or passed on to their heirs,” said CCH IRA/Pension Analyst Nicholas Kaster, JD.

The Roth Difference

Roth IRAs were established by the Taxpayer Relief Act of 1997 and first became available in 1998. As with traditional IRAs, 2008 contribution amounts to Roth IRAs are limited to $5,000, plus an additional $1,000 catch-up contribution for individuals who are age 50 or older. However, the income restrictions, eligibility rules, tax consequences and distribution requirements all differ from traditional IRAs.

Eligibility to make contributions to a Roth IRA depends on the income level of the individual. The maximum annual contribution that can be made to a Roth IRA in 2008 is phased out for single taxpayers with AGI between $101,000 and $116,000 and for joint filers with AGI between $159,000 and $169,000. Additionally, all contributions to a Roth IRA are nondeductible. However, the earnings grow tax free with no taxes owed on qualified distributions. Unlike a traditional IRA, there are no required minimum distributions from a Roth IRA.

Since their introduction, Roth IRAs have gained some traction among taxpayers, however, the changes are anticipated to increase their popularity and accessibility even more, according to Kaster.

Rolling Over a 401(k) into a Roth IRA

Before the Pension Protection Act changed the rules for 2008 forward to allow direct rollovers from a qualified plan – such as a 401(k) – to a Roth IRA, individuals who wanted to move funds from their 401(k) to a Roth IRA had to first transfer the funds to a traditional IRA and then convert them to a Roth IRA.

While the new rules will certainly streamline Roth IRA conversions, it doesn’t mean that it’s best for everyone. According to Kaster, there are a few questions to consider before converting to a Roth IRA:

• Are you going to need the assets within five years of conversion? If converted amounts are withdrawn within five years, a 10-percent additional tax applies unless the IRA owner is over age 59½ or one of the early withdrawal exceptions apply.

• Where do you think your tax bracket will be in retirement? Individuals who expect to be in a higher tax bracket during retirement may find it advantageous to pay the taxes on a Roth conversion at their current lower tax rate rather than paying taxes on required distributions from their traditional IRA at higher tax rates.

• Do you have money in non-retirement assets to pay the conversion taxes? Roth IRA conversions trigger a tax to the account holder. It is preferable for an account holder to use non-retirement assets to pay the conversion taxes.

• Will you need the income in retirement? Whereas traditional IRAs are subject to required minimum distributions, Roth IRAs are not, thus allowing funds to continue to accumulate if they are not needed for living expenses during retirement. Because no minimum distributions are required during the account owner’s life, a Roth IRA is an excellent vehicle to pass on wealth to the next generation.

• Is your AGI below $100,000? If you earn more than $100,000, you are precluded from making a Roth IRA conversion, at least until 2010.

Positioning for 2010 Roth IRA Conversions Already Underway

While current law restricts individuals who have an AGI of more than $100,000 from converting to a Roth IRA, this income limit will be eliminated starting with the 2010 tax year. At that point, assuming no further change in the law, the income limit on making conversions would be lifted, while the income limits on making Roth IRA contributions would still be in place.

According to Kaster, people planning to make the conversion may already be positioning themselves to take full advantage of the new rules.

“A taxpayer could make a contribution to a nondeductible traditional IRA, which has no income limit. Then beginning in the 2010 tax year, they could convert their nondeductible traditional IRAs into Roth IRAs, essentially circumventing Roth IRA income limits,” said Kaster.

He noted that such taxpayers would owe taxes only on the earnings in the nondeductible account, if that were their only IRA account. Otherwise, the tax would be based on the taxable portion of all IRA accounts held. He further noted that, starting in 2010, a taxpayer could continue making contributions to a nondeductible traditional IRA and then convert it to a Roth IRA the next day to realize no taxable income. Distributions from the Roth could then be taken tax free if the account has been open five years and the taxpayer is over age 59½.

Taxpayers making a conversion in 2010 will have the added bonus of being able to pay the taxes on a pro-rata basis over 2011 and 2012, helping to soften the tax consequences.

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals and their clients since 1913. Among its market-leading products are The ProSystem fx® Office, CorpSystem™, CCH® Tax Research NetWork™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill.

Wolters Kluwer is a leading global information services and publishing company. The company provides products and services for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory sectors. Wolters Kluwer has 2006 annual revenues of €3.4 billion, employs approximately 18,450 people worldwide and maintains operations across Europe, North America, and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. Its shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices. For more information, visit www.wolterskluwer.com.

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