Correction to This Article
This article should have noted that the maximum income allowed for converting a standard individual retirement account to a Roth IRA is different from the maximum allowed for contributing to a Roth IRA. Only taxpayers with modified adjusted gross income of $100,000 or less may convert a standard IRA to a Roth IRA. Also, the act that allows conversions to Roth IRAs in 2010 regardless of income is the Tax Increase Prevention and Reconciliation Act of 2005, not the Pension Protection Act of 2006.

Ahead of the Rise in Stocks and Taxes, Switch to a Roth

By Martha M. Hamilton
Sunday, May 4, 2008

Panic set in almost as soon as I woke up.

The night before, I had rolled over about $130,000 from my traditional individual retirement account to a Roth IRA, thinking it was a smart thing to do. I made the move for tax reasons.

Money you put into a traditional IRA is exempt from taxes until you withdraw it. By contrast, you pay taxes upfront on the money you put into a Roth -- but after that, you never pay taxes on either your contribution or your investment gains again.

It seemed a savvy move to sink my funds into a Roth -- and suffer the tax bite now -- when my funds were substantially less, thanks to the recent market downturn. I would pay lower taxes going in and -- more important -- I would pay no taxes on gains I expect when the market eventually rebounds.

Pretty shrewd. But as I opened my eyes the next morning, I sat bolt upright. Did I blow it?

Had taking the distribution from my regular IRA put me above the income limits for a Roth? As an individual, if you want to open a Roth, you cannot earn more than $116,000. (The limit for a married couple filing jointly is $169,000.) Would the $130,000 catapult me beyond the limit and trigger penalties?

As it turned out, the answer was no. Shifting funds from a traditional IRA to a Roth isn't counted as income for the purposes of establishing eligibility, so I was still safely under the limit with my pensioner's income.

But it took a while before I could breathe easily again.

You might think that because I write this column, I could call smart financial people and find out what I should do with my own money. But I don't, both because it wouldn't be right to use the column for personal benefit and because I like the adventure of trying to figure things out on my own. Sometimes it works, and sometimes it doesn't.

Once, many years ago, when I was working for the New York Journal of Commerce, I thought I'd learned a few things about the stock market. As a result, after reading about Kentucky Fried Chicken's hot prospects in the Wall Street Journal, I started watching the stocks tables with an eye toward investing in the Colonel's company. It was only when I was ready to place an order for shares that I discovered I had been following a company called Colonial Sand.

In this Roth case, however, I am confident I made the right decision. And if you're eligible, I believe you, too, might want to consider shifting assets from a traditional IRA or retirement savings plan to a Roth.

Here's why. If you have to pay taxes, it is better to pay taxes on an investment when its value has dropped. For instance, the mutual fund that I transferred to my Roth account was worth about $70,000 more a year ago than it was when I made the switch. That's $70,000 on which I won't pay taxes. Assuming the mutual fund recovers once the current slump ends and continues to grow, I'll be able to withdraw all that money in the future tax free.

When you transfer funds to a Roth IRA, the transfer agent takes out taxes and sends them to the IRS. In my case, the mutual fund company took out 20 percent. With the $70,000 drop in the value of the fund, I reckon I paid about $14,000 less in taxes than I would have if I did the same transaction a year ago.

After I'd recovered from my little heart-stopping adventure, thanks to my lawyer sister JE McNeil, who read me the language in the tax code about the transfers and income eligibility, I talked to IRA expert Ed Slott. Slott reiterated what JE told me and went on to say why he thinks that anyone who can transfer funds to a Roth IRA now should do so.

"Anytime now in this environment is great," he said. "Taxes are low, and stock values are low." Like many people, Slott believes that tax rates will rise because of the growing deficit and other demands on the nation's finances. "Say you have an IRA that was worth $100,000 and now it's worth $70,000," he said. If you shift to a Roth, "you're buying it at a discount."

Though taking funds out of a traditional IRA could push you into a higher tax bracket, Slott thinks it is still worth doing. He noted that many people can start shifting funds to an IRA without worrying about a higher rate. "A lot of people are not maxing out in their tax brackets," he said. For instance, if you are single and your taxable (not total) income was $80,000 in 2008, it would take $84,550 in additional taxable income to push you from the 28 percent bracket into the 33 percent bracket. And being pushed into a higher tax bracket does not mean that all your taxable income is taxed at the higher rate. Only the amount that got you into the next bracket is taxed at the higher rate.

"Whatever tax you're paying, it will be cheaper," Slott said. "The longer you wait, the more the [traditional] account grows, so you're going to be paying taxes on more money." The IRS makes it mandatory at age 70 1/2 , the age at which it requires that you start taking out the money and paying taxes on it.

In two years, it will be even easier to shift to a Roth IRA. As a result of the Pension Protection act of 2006, everyone, regardless of income, will be able to do so in 2010. Slott calls it "the deal of a lifetime." You don't have to report any income from the conversion in 2010; you report half of it in 2011 and the other half in 2012, which spreads out the taxes.

In the meantime, "it's not all or nothing," he said. "You do a little. You use up your brackets each year. The idea is to set yourself up to have tax-free funds when you're retired. The last thing you want in retirement is to reach your hand in there and find you're being taxed at a 75 percent rate. A Roth IRA removes the uncertainty of what future tax rates might be."

Okay, I'm feeling vindicated.

2nd Chance for the Stimulus

If you did not have enough income to file an income tax return for 2007, you may still qualify for the economic stimulus payment the federal government will be sending to consumers. As long as you have a combination of $3,000 in payments from Social Security, Railroad Retirement, certain veterans or disabled and survivors benefits, combat pay or earned income, you can file a form 1040A. The good news is that, even though the tax deadline has passed, you haven't missed the train. You have until Oct. 15 to file for the payments, which are $300 if you're single, $600 if married and an additional $300 for each child under 17. You can find step-by-step instructions or use the AARP/NCOA online tool at

Join Martha M. Hamilton and Christine S. Fahlund, senior financial planner for T. Rowe Price, for an online chat at noon Tuesday at

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