Roth IRA: Opportunities and Insights

Q & A with Jim Brown, Senior Vice President of Personal Retirement Solutions and Heather Walsh, Wealth Management Advisor, for Merrill Lynch Wealth Management, Boston, MA

What are the differences between a Traditional IRA and a Roth IRA?

An IRA is an account that provides you with certain tax advantages for saving for your retirement. If you are eligible to contribute to a traditional IRA, your assets may grow tax-deferred, and distributions taken after age 59½ generally are taxed as ordinary income. Traditional IRA contributions may be tax-deductible, depending on your tax-filing status, your Modified Adjusted Gross Income (MAGI) and whether you and your spouse participate in employer-sponsored retirement plans.

Annual contributions to Roth IRAs are not tax-deductible, however, there are restrictions on the ability to open and contribute to a Roth depending on earned income levels and filing status. These assets grow free from federal income tax, and you are not required to pay federal income tax on withdrawals if you have had the account open for at least five years and are age 59½ or older, or you meet another exception. Roth IRAs are also not subject to required minimum distributions during the investor’s lifetime.

Simply put, the main differences between a Traditional IRA and a Roth IRA are the eligibility requirements, the way contributions and distributions are treated for tax purposes, and the rules around required minimum distributions.

What does the new tax law mean to me?

The rules on contributions are not changing, what is changing are the rules around converting a traditional IRA to a Roth IRA. Currently, the MAGI restriction on the ability to convert a traditional IRA to a Roth IRA is $100,000. This limit is repealed as of January 1, 2010 for investors who wish to convert their traditional IRAs or 401(k) assets to Roth IRAs. It will now be possible for everyone — regardless of income — to convert their traditional IRAs or 401(k)s into a Roth IRA beginning in 2010.

Is now the right time for me to a convert from a Traditional IRA to a Roth IRA?

The short answer is that it really depends. For instance, if you believe that your tax bracket/tax rate may be higher in retirement and you have funds outside of the IRA to pay the taxes it may make sense. Additionally, if the recent market fluctuations have decreased your account balance, it may be beneficial for you to convert a portion of your IRA assets to a Roth IRA. Doing so may lower your tax liability, as income taxes are due on the portions of converted assets that are tax-deferred (i.e., deductible contributions, rollover of pre-tax deferral and earnings). Also be aware that for conversions completed in 2010, federal taxes may be equally split between 2011 and 2012. Finally, if you are looking to your IRA as part of your estate that you are earmarking for your heirs, there is the ability to pass on these funds and provide an inherited tax-free stream of income.

Whatever you decide, it is important to consider the pros and cons of a conversion, particularly when it comes to understanding your tax liabilities.

Because there are so many considerations involved, it’s important to talk with your Financial Advisor and your tax professional to ask if converting to a Roth IRA may be right for you. They can help you determine whether this new opportunity can help you achieve your retirement savings goals.

Heather Walsh; Merrill Lynch Wealth Management; heather_walsh@ml.com