The Future Tax on Roth IRAs

Putnam recently surveyed clients about this and found that investors who could pay the taxes on their tax-deferred accounts now, at their current tax rate, are not flocking to this retirement product the way they assumed they would.  The Putnam Investments LLC survey was focused on the higher tax bracket IRA owners who could take advantage of the window of opportunity that would allow them to spread their tax liability over 2011 and 2012 making their future tax obligation disappear.

According to Christine Fahlund, senior financial planner for Baltimore-based T. Rowe Price Group Inc. the fear of the government lifting the tax-free status of these plans would leave the higher income earners – the IRS lifted the income restrictions which had previously been at $100,000 – in jeopardy.  She said in a recent Bloomberg article: “If that happened, you would have accelerated your tax payments unnecessarily.”

The rules for conversion are not to be ignored.  Following the market downturn, some investors are looking to this conversion for IRAs that lost money.  This would lower the overall tax obligation.  But be careful, especially if you have non-deductible contributions in those IRAs.  The IRS rules force you to convert all of your IRA holdings, not just the ones that have shown losses.

(Keep in mind that it is not a good ide to takes a withdrawal from your IRA to pay for the conversion – instead, opt for the two year payment of those taxes.)

In many instances, paying the tax now would benefit a great many investors.  But I am not seeing the benefit unless you assume a higher tax bracket, assume the government will eventually tap these plans for taxes later, or you are too close to retirement to make it matter.  Perhaps the best option would be to simply open a Roth IRA for all future retirement investments, leaving the traditional IRA to be taxed at whatever future rate will be levied.

Read the full article about this failure to convert by Margaret Collins.