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that has precluded most physicians and dentists from converting traditional IRA balances to a Roth account will be repealed.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 on this subject (Part 2 of 3), here are six reasons and strategies for physicians and dentists to consider in converting from a Traditional IRA to a Roth:
- Take advantage of today’s lower tax rates – obviously, no one really knows for sure what direction income tax rates will go in the coming years, but it seems very likely, based upon current and proposed government spending, that future income rates will increase. By converting dollars from a traditional IRA to a Roth IRA and paying the tax required on this income at current rates for 2010, you stand to save tax dollars. If you desire, you can elect to pay the tax due over tax years 2011 and 2012, but the chances of tax rate increases in those years are greater. If you aren’t so sure that rates will go up in the future, but you don’t want to take a chance that they will, then convert just a portion of your IRA. Higher income tax rates in your future may also be caused by the distributions you will need in future years. If your planned lump-sum distribution will cause you to move up a tax bracket in the year in which you need the money, consider converting a series of distributions that will keep you in the lower bracket each year leading up to the year in which you anticipate needing the money.
- Use up charitable deduction carry-forwards – I find that clients in their retirement years who are inclined to continue their charitable contributions may have limits placed upon their contributions because their taxable income isn’t high enough to take the full deduction. By converting a portion of their IRA to a Roth we are able to take a larger charitable deduction and not necessarily increase their tax liability.
- Utilize high basis in non-deductible IRA – Over the past several years, I have recommended that physician and dental clients consider making contributions to their IRA account even though it was not tax deductible (see Part 1 for a discussion on deductible vs. non-deductible IRA’s). This action has caused their “basis”, or portion of the balance that represents their contribution, to be high as compared to the IRA overall value. Of course, the stock market decline prior to this year has also contributed to this factor. Converting your regular IRA to a Roth in situations where you have a high “basis” could mean that you will pay minimal or no additional tax. Keep in mind, though, that all IRA balances are considered and not just the non-deductible account that you may have segregated into a separate account.
- Estate Planning – you may find, in your retirement years, that you don’t need the all of the “nest egg” that you have acquired over many years of saving and you desire to leave a portion of this money to your heirs. Roth IRA’s provide a for a more efficient way of leaving retirement plan money to your children or grandchildren. Distributions from traditional IRA’s, for example, require that your kids pay income taxes on the money they receive at their rates. Roth IRA distributions from an inherited Roth IRA would be exempt from personal income taxes. The other advantage that Roth IRA’s have over Traditional IRA’s is the fact that you are not required to take an required minimum distributions after age 70 1/2.
- Use non-qualified money to pay the tax – Physicians and Dentists should use money outside of their qualified retirement plan money to pay the tax associated with the conversion. Using funds, outside of your qualified retirement money, even if you are 59 1/2, will generally enhance your overall future wealth.
- Contribute and then Convert – As noted above, the income limitations for converting from a traditional IRA are soon to be repealed. However, the income limits for making a current Roth contribution remain in effect. Assuming you don’t have a traditional IRA to convert and you are subject to the income limits for making a contribution, you can still make a contribution to a Roth IRA by first making a non-deductible contribution to a traditional IRA account and then immediately converting it to a Roth IRA.
There’s an old saying that hindsight vision is 20/20. On the next post we will consider a strategy that will allow you the ability to correct the timing of your Roth conversion.
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