As we’ve discussed in previous posts, 2010 is the year Congress has allowed everyone, regardless of income, to convert their traditional IRAs to Roth IRAs.  There’s only six months left for the conversion, which noted economist Arthur Laffer says is a “no brainer” thing to do, for reasons beyond the savings of income taxes in the future.  Many taxpayers already have taken advantage of this opportunity.  According to Fidelity Investments, as of May 31, more than 87,000 of its customers have converted from a traditional IRA to the Roth IRA this year.

But, the very statement that the conversion to a Roth IRA eliminates income taxes in the future, given the current political environment of deficit spending, raises the question of whether the converted Roth IRAs may be subjected to income taxation in the future, as a result of Congressional greed for more tax revenues. That question causes wary citizens to evaluate the odds of that happening, especially for high income individuals who President Obama has repeatedly singled out as a target for tax increases.

None of us can foretell the future actions of Congress, but it is highly unlikely that Congress would subject Roth IRAs, especially conversions, to future income taxation – that would essentially result in the double taxation of your salary. 

The basic distinction between traditional IRAs and Roth IRAs is this:

1. With traditional IRAs, contributions usually come from pretax earnings, so withdrawals from the regular IRA are taxable.
2. With Roth IRAs, come from after-tax money, so withdrawals are tax free.

The other differences between traditional IRAs and Roth IRAs, increase the benefits of converting the regular IRAs to Roth IRAs this year.

1. Unlike regular IRAs starting at age 70 ½ , there are no mandatory required minimum distributions for the Roth IRA.
2. Very importantly for top earners, Roth IRAs are not subject to the new 3.8% Medicare tax on investment income that will take effect in 2013 as part of “Obamacare.”
3. Withdrawals from Roth IRAs don’t raise Medicare premiums or taxes on Social Security income, whereas regular IRA withdrawals do.
4. Obviously, if income tax rates increase more than they already are scheduled to do in 2011, the Roth IRA withdrawals will not be subject to the increase in the income taxes, whereas withdrawals from a regular IRA will be subject to those increases.

Roth IRAs are also effective estate planning vehicles.  Converting a Roth IRA reduces the size of a taxable estate.  Roth IRAs transferred to heirs at death can be compounded for decades after death.

The only real downside of converting is that you must pay income tax on the amount of the traditional IRA that you are converting to the Roth IRA.  For conversions in 2010, you can spread the payment of the additional income tax over two years.  Using certain types of investments, you may be able to recoup some, or all, of the income taxes caused by the conversion.

According to the Wall Street Journal Tax Report column, there are some indirect ways through which Congress could seek to impose future tax burdens on converted IRAs, including an excess retirement income tax (as was used from 1987 to 1997 – repealed because it was such a hated tax), through modifying the definition of Medicare and Social Security income, taxing earnings, or perhaps indirectly through a value-added (VAT) tax.

However, with the flood of revenue coming to the Treasury from the tax generated by the Roth conversions occurring in 2010, it is most unlikely that Congress will take any such action for a long time, if ever.

Even Warren Buffett’s billionaire partner Charlie Munger told attendees at this year’s Berkshire Hathaway meeting that he is converting his old IRA to a Roth IRA, and is planning to leave the account to his heirs, including his children and his grandchildren.  His comment:  “I think it just makes sense.”

For those who have not yet evaluated the benefits of a Roth IRA conversion, only about six months remains of the special rules that allow the Roth IRA conversion in2010 without regard to income limits and allow the payment of the tax liability over the next two years.  To take advantage of these provisions, the Roth IRA conversion must be complete before the end of the year.

If we can assist you in determining whether, and if so, how much, of your regular IRA you can convert to a Roth IRA, in an income tax efficient manner, just call our office (904-448-1969) to schedule a no-cost, no-obligation consultation.  We can help you determine how much you and your heirs can benefit from a Roth IRA conversion.