I have a few clients that started a Roth IRA in their college or residency years; however, most physicians and dentists with whom I work do not have Roth IRA’s because the income limitations associated with Roth contributions have made it impossible for them to start one.
Recently, I have had several physician clients inquire about the possibility of converting their “Traditional IRA” account to a “Roth IRA” in 2010. Beginning on January 1, 2010, the modified adjusted gross income limit of $100,000 that has precluded most physicians and dentists from converting traditional IRA balances to a Roth account will be repealed. This change in the tax law will allow affluent taxpayers the significant opportunity to move funds from a tax-deferred status to a situation where future distributions may be tax-free.
The intent of this series is to provide you with some basic strategies and information on Roth Conversions for 2010. The concepts and strategies offered here may not be right for you. For a more specific tax analysis of your personal situation, you should schedule a consultation with your tax preparer or financial planner.
For today’s post (Part 1 of 3), let’s consider some basic concepts of the two types of IRA’s that are generally available today:
Traditional IRA – these Individual Retirement Accounts allow the income or capital gains in your “nest egg” to accumulate without having to pay current taxes on your earnings. Contributions are either tax deductible as an income adjustment on your personal tax return, providing for tax current tax savings. Or, because of participation in another qualified retirement plan and income limitations, the contribution to your account is considered to be a “Non-Taxable” contribution. In the case of the non-taxable contributions, taxpayers file a form 8606 with their tax returns, which reports the contribution type to the IRS and tracks your contributions from year to year as additional contributions are made. The filing of this form becomes an important factor for the year in which you receive distributions from your IRA or, for the purpose of this summary, the year in which you convert to a Roth IRA. When you convert to a Roth or begin to take distributions from a regular IRA you pay taxes on this ordinary income based upon a computation that takes into consideration your non-tax contributions.
Roth IRA – like the traditional IRA’s, your “nest egg” can grow without having to report and pay current taxes on the earnings in your account. Unlike the traditional IRA, contributions to a Roth do not afford the ability to deduct the contributions from your taxable income and thus, do not allow for current year tax savings. Your savings comes in future years when “qualified” distributions are made from your account and considered exempt from income taxes. A distribution is considered to be qualified if made: once you reach age 59 1/2, upon death or disability, or (up to $10,000 per lifetime) for first-time homebuyer expenses. However, and this is a key consideration, a distribution is not considered qualified if made within the five-year period beginning with the first tax year you made a contribution to a Roth IRA.
The first, and probably the most important, reason for converting your traditional IRA to a Roth IRA (even if it is a partial or small contribution) is that you need to get the “five-year period clock” ticking to take advantages of the strategies that I will outline in my next post.
Mike DeVries is a CERTIFIED FINANCIAL PLANNER ™ and a Certified Healthcare Business Consultant focusing on helping healthcare professionals. If you would like to learn more about becoming a client of Mike’s, contact him at www.vmde.com