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By Cory Bowman
The profession of being a retirement income specialist is a rewarding and steady job. There are many advantages to becoming a retirement income specialist; helping others and finding challenges and enjoyment in your work are some of the main positives. To become a retirement income specialist, one must usually enroll in a courses or programs to meet certain requirements and to learn the ins and outs of the field. One specific topic that a course might cover is Roth IRAs, and in particular: Conversions.
Roth IRAs are flexible investments (usually with more options than other traditional IRAs). There are many laws governing the implementation of these Roth IRAs, so a retirement income specialist must always stay up to date with the current laws. Starting January 1st, 2010, an income limit that previously prevented many Americans from converting their traditional IRAs into Roth IRAs disappeared. If your clients household income is more than $100,000 (the previous limit), converting to a Roth will be an option for the first time. Married couples filing separate tax returns also will now be able to convert. Listed below are strategies for the advisors consideration.
Pay taxes on converted amount
You have to pay income taxes when you convert. For example, a client in the 28% tax bracket will owe $28,000 (plus state income taxes) on a $100,000 conversion.
Converting may benefit the client in the long runif a higher tax rate is expected during retirement. If, like most people, the client is not sure about his future tax rate, consider converting just part of his traditional IRA to a Roth. Doing so gives “tax diversification” because some money would be in a Roth and some still in a traditional IRA.
Consider source used for taxes
Stick with the traditional IRA if the client does not have money available outside of the IRA to pay conversion taxes. Pulling money out of an IRA to cover taxes can defeat the purpose of making the switch in the first place. By reducing retirement savings, clients reduce the ability to generate future tax-free earnings on money invested in the Roth. If under age 59, amounts pulled out of a traditional IRA to cover taxes may be subject to a 10% IRS penalty.
Two conversion strategies
If the client does not have enough money to pay taxes on all converted assets, or if doing so would push her into a higher tax bracket, consider converting just part of the traditional IRA assets. A special option applies only to 2010 conversions; the taxpayer can elect to evenly divide the tax liability over 2011 and 2012. If tax rates go up in 2011, this split-year strategy may not be a good idea.
Longer time horizons are better
A conversion may not be wise for clients who expect to withdraw money within five years. Generally speaking, the client will only be able to withdraw earnings from the account without taxes and penalties if age 59 or older and a Roth IRA has been held for at least five years. Withdrawals of the original conversion amount are always tax-free; however a 10% early penalty may still apply. The client must be either at least age 59 or wait at five years after the conversion to make the withdrawal in order to avoid the 10% penalty.
Heirs can benefit
During lifetime, the Roth IRA client is not subject to RMDs, meaning the entire amount can be left to someone else. A beneficiary who inherits a Roth IRA may be subject to RMDs, but withdraw the original conversion tax-free. Earnings are also tax-free, provided the Roth IRA meets the five-year holding requirement.
About the Author: Cory Bowman is Director of Ops at the Institute of Business Finance. IBF has helped thousands of members of the financial services industry attain designations. For more information about becoming a
retirement income specialist
, visit http://www.icfs.com
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