) -- Roth IRAs became the biggest topic in retirement investing this year. But it seems there's always more to know.
Starting Jan. 1, higher-wage earners for the first time won't be locked out of participation. The $100,000 salary cap will be waived for conversions from traditional individual retirement accounts, though not contributions. The key to deciding whether a Roth conversion is of value is whether the advantage of tax-free investment growth, as offered by a Roth plan, is more beneficial than paying taxes upon distribution. A Roth plan, for example, might prove a worthy hedge against a rising tax bracket.
The need for guidance on the matter has driven many to seek the counsel of such firms as
T. Rowe Price
. For their part, advisers have bombarded existing and potential clients with Roth-related materials and advertisements. Fidelity, for example, has gone as far as supplementing its marketing campaign with Roth billboards that dot major roadways.
Digging deeper into Roth plans, there may be lesser-known factors that bear consideration, according to Rande Spiegelman, vice president of financial planning for Schwab.
A loophole for the affluent:
There remains a way around income caps, even when it comes to contributions.
As the law currently stands, starting in 2010, high earners otherwise ineligible to make Roth contributions could make nondeductible contributions to a traditional IRA and then convert to a Roth the next day with no tax consequences. That could be repeated every year, circumventing the Roth contribution income limits.
"I assume that if Congress intended on abolishing the Roth IRA contribution limits they would have done so," Spiegelman says. Still, the law may soon be changed, he says.
An individual can't choose which portion of traditional IRA money he wants to convert, and the government looks at all traditional IRAs as one when it comes to distributions, including Roth conversions. Traditional IRA balances are aggregated so the amount converted consists of a prorated portion of taxable and nontaxable money.
Multiyear tax payments:
To make dealing with the upfront tax burden that a Roth conversion entails, the IRS allows the hit to be spread over multiple years. But being able to split the conversion income between 2011 and 2012 for 2010 conversions is a potential benefit only if an individual's tax rate doesn't rise. That may be a big assumption as many expect higher rates in 2011 and 2012 as a near certainty for top earners.
The perils of simplifying:
Schwab's Spiegelman says online Roth conversion calculators and other guidance tools should only be treated as a starting point for evaluations.
"These tools do a good job of giving a reasonable picture, but it is a general picture of where you might be," he says. "These calculators are not robust tax preparation tools."
Look before you leap:
Tax issues are crucial to evaluate. Consider paying the upfront taxes from a source other than an IRA. Failing to do so could greatly reduce the ultimate benefit of conversion.
"One of the things we need to keep in mind here is that Congress is not allowing us to do a Roth conversion out of the goodness of their heart," Spiegelman says. "This is all designed to generate tax revenue for the U.S. Treasury that might have otherwise been locked up for decades. Any time you get to pay a tax sooner rather than later, you've got to ask yourself, 'What's the catch?' "
-- Reported by Joe Mont in Boston.