Since their inception in 1998, the Roth IRA has been one of the best retirement accumulation vehicles available and we at Dowley & Company have attempted to take advantage of it whenever we can.  Unfortunately, Roth IRAs are currently unavailable to a whole group of people due to income restrictions.  Individuals with modified adjusted gross income of $120,000 or more can't contribute to one of these accounts. For married couples, the threshold is $176,000.  Individuals with modified adjusted gross income of more than $100,000 and married taxpayers who file separate returns are barred from moving assets held in traditional IRAs into Roth IRAs.

For 2010, Uncle Sam has eliminated both the income and filing-status restrictions on transferring money from a traditional IRA to a Roth, a procedure known as converting. So, anyone willing to pay the income taxes due upon making such a move will be able to transfer retirement savings into a Roth, where it can grow tax-free. The income restrictions are still in place for high-income taxpayers virtually eliminating the possibility of making contributions for many of our clients. But the possibility of a Roth conversion creates a unique opportunity for these high-income individuals for this one year only.

Why bother with a conversion? Roth IRAs have several advantages over traditional IRAs.  Perhaps the biggest one concerns taxes. For the most part, withdrawals from Roth IRAs are tax-free as long as an account holder meets the rules for minimum holding periods. If you convert assets to a Roth from other IRAs or retirement plans, you have to hold those assets in a Roth for five years, or until you turn age 59½, whichever comes first, to make penalty-free withdrawals on your converted amounts. Each conversion has its own five-year clock.

Unlike traditional IRAs, Roth accounts have no required distributions. With a traditional IRA, individuals are required to begin taking those pesky withdrawals after reaching age 70½. Roth accounts aren't subject to mandatory distributions, so the money in a Roth can grow tax-free for a longer period of time.

If you are planning to leave your IRA to heirs, the Roth has yet another advantage. Although people who inherit both traditional and Roth IRAs must make annual withdrawals from those accounts (based on their life expectancies), Roth beneficiaries owe no income tax on the money.

So what is the catch?  When you withdraw money from your traditional IRA, you will have to pay income tax on the withdrawal, or on the portion of it that represents pretax contributions and earnings.  In 2010, Uncle Sam is offering taxpayers who convert a special deal: They can choose to report the amount they convert on their 2010 tax returns, or they can spread it equally across their 2011 and 2012 returns. (If you are worried that Congress may raise tax rates, consider paying the tax bill in 2010.)

We at Dowley & Company are considering this opportunity for all of our clients. One of the considerations to take into account is whether a particular client has assets that can be used to pay the income taxes on such a conversion. It is generally best to not have paid the taxes out of the IRA itself. This only causes an increase in taxable income on the money used to pay the tax itself. It is also a consideration that the Roth IRA needs to stay in the account for over five years to avoid any penalties on withdrawal.  We also like to consider the taxation of all our client's income sources. Having a tax-free income from a Roth helps to balance out other taxable sources of income during retirement. This not only helps to increase a client's retirement income in a tax-free way but also alleviates taxation on other sources such as Social Security.

If you have any questions regarding a Roth IRA conversion, please do not hesitate to contact us 781-631-4100 or email cdowley@dowleyandco.com