Is a Roth roll-over right for you?

“The point to remember is that what the government gives it must first take away.” John Strider Coleman (1897-1958) American business executive

 “The Roth IRA is the single best gift Congress has ever presented to the American taxpayer. It allows us to build a retirement account that will grow to incredible size, and remain free of income tax forever. There is only one catch: You have to pay the income tax up-front.” Ed Slott in The Retirement Saving Time Bomb, p. 203

 We have been schooled from our early years to think that the ONLY way to think is to shelter your income from taxes. What do I mean? It is a great benefit to be able to put our retirement money into a plan that shelters it from taxes from the government and allow that “nest egg” to grow and compound over decades. Fortunately, there is a 10% penalty if we take money out of our retirement plan before we are 59.5 years old. Fortunately, because that forces us to keep the money in this tax shelter until we are going to retire.

 There are exceptions to this 10% early withdrawal penalty which can be found here.

So if you putting money away for retirement in an IRA, 401(k) or other retirement plan that is good. However, there is a time when it is beneficial to NOT put all your money in a place where it is sheltered from taxes.

 If you are married and filing a joint return and your AGI (adjusted gross income) on your 1040 tax form (line 37 on the 2011 1040 tax form) is below $69,000, then you have an opportunity. For the year 2011, your ordinary income is taxed at this rate:

  • 10% on taxable income from $0 to $17,000, plus
  • 15% on taxable income over $17,000 to $69,000, plus
  • 25% on taxable income over $69,000 to $139,350, plus
  • 28% on taxable income over $139,350 to $212,300, plus
  • 33% on taxable income over $212,300 to $379,150, plus
  • 35% on taxable income over $379,150.

Let’s assume that your AGI is $49,000. (Line 37 of your tax form). You can roll over $20,000 from your IRA into a Roth IRA and be taxed that year at 15%.

 Why would you want to do that?

  1. That $20,000 will get taxed sometime. The government will have their day, and if it is taxed later, there is a very, very good chance it will be taxed at a higher rate. People think that they will be in a lower tax bracket when they retire. But that is a myth.
  2. All future earnings on that $20,000 are never taxed again.
  3. It can be stretched over decades and even given to your heirs and they can stretch this until they are 70.5 years old. (This is more complicated that this blog can adequately cover. Go see an CPA)
  4. When you get to 70.5 years old, the government has the Required Minimum Distribution (RMD). They don’t want you to shelter that money forever! It’s time to start paying for all those good years of having your money compounded. Roth IRAs are exempt from this RMD.

 The down side of rolling money from an IRA into a Roth IRA is that you have to pay taxes NOW on that rollover which is called ordinary income. In the example above, your will be paying 15% on the $20,000 rollover or a tax of $3000. If you do this every year from 50 to 70, then you will have put $400,000 into a Roth whose earning will never be taxed again, and never at this lower  tax rate that will almost certainly go up as the government seeks new revenue to pay for the $15 Trillion Dollars we have in debt.


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