June 2006 News Update

The Tax Increase Prevention and Reconciliation Act, signed into law by President George W. Bush on May 17, 2006, provides higher income taxpayers with another retirement planning opportunity.

If you qualify, you may be able to make a Roth IRA (Individual Retirement Account) part of your retirement plan due to a provision that lifts income limitations on rollovers to these types of IRAs.

First, let's review how Roth IRAs differ from traditional IRAs. Contributions to Roth IRAs are not deductible, but the withdrawals from the account, including all the buildup in value over the years, are tax-free as long as certain conditions are met. The conditions are that the withdrawals are made five years or more after the account was opened, and after you attain age 59 1/2 or have become disabled.

Currently, the law allows you to convert an IRA to a Roth IRA if your adjusted gross income is under $100,000 (single or joint), without incurring a withdrawal penalty. The newly enacted tax law provides that, beginning in 2010, the $100,000 income limitation is removed and higher income taxpayers can roll over an IRA to a Roth IRA. The amount being rolled over must be included in gross income, so taxes will be due, but they can be spread over a two-year period if the rollover is made in 2010. And a withdrawal penalty will not be imposed.

Should you take advantage of this new rule if you qualify? The answer may very well be yes. Qualified withdrawals from Roth IRAs are not taxable, and Roth IRAs are not subject to the minimum distribution requirements at age 70 1/2 of Traditional IRAs.

Your retirement plan should take into consideration the tax rate you will be subject to when you retire. It's likely that you have a good idea of what your income stream will be when you're ready to retire and the resulting tax consequences. And while you cannot predict whether tax rates will go down in the future, it is a fact that the current lowered tax rates are due to expire after 2010.

Last, while the Roth IRA conversion changes go into effect in 2010, you may be able to incorporate this new provision into your retirement planning as early as this year. Even if the income limitations render your current contributions to a regular IRA nondeductible, you may want to consider making nondeductible contributions to a regular IRA anyway, before 2010, and then convert the IRA into a Roth IRA in 2010. The nondeductible contributions will not be subject to tax during a Roth conversion, although any accumulated earnings will be.

Again, while part of the amount being converted is considered a taxable distribution, the taxes can be spread over a two-year period if the rollover is made in 2010 and the lower income tax rates will still be in effect. A smart move for those in a higher income bracket.