Save on Taxes With New IRA Rules

Friday, Jul 10,2009, 1:51:01 PM Click:

A change in tax rules, which will allow savers at any income level to take advantage of Roth IRAs, could mean a lower tax bill for you come January.

Currently, retirement savers who make more than $120,000 including certain deductions can't convert their funds to a potentially tax-advantaged Roth IRA. Traditional IRAs and 401(k) funds are taxed on their way out (when you take a distribution), while Roth IRAs are funded on the way in, with after-tax money. The distributions are then tax-free.

As of January 2010, the income cap preventing those with a modified adjusted gross income of more than $120,000 a year (or $176,000 or more if you're married and filing jointly) from converting their retirement savings to a Roth IRA will be lifted, according to a report in The Wall Street Journal.

Here's how the new policy could affect you:

More Options: The elimination of income limits means that people with higher incomes and retirees who've already rolled over their 401(k) and other retirement savings plans can convert their funds to a Roth IRA.

Lower Taxes: A Roth IRA is a good idea if you expect to be in a higher tax bracket in retirement than you are now, whether it's because you'll be earning more, you expect an inheritance, or for any other reason. If you expect to be in a higher tax bracket when you retire, paying taxes on your retirement funds beforehand would mean you'd pay at a lower tax rate, meaning you'd pay less in taxes overall.

Access to More of Your Money: If you cash out a traditional IRA or 401(k) before you're 59 and a half, you're subject to hefty taxes and penalty fees. But if you've had a Roth IRA for more than five years and you're at least 59 and a half, you can make a tax- and penalty-free withdrawal any time. And if you need access to your money before that, you'll only have to pay a 10% penalty.

Save More for Later: If you have a traditional IRA, you have to start receiving distributions once you hit 70 and a half. With a Roth IRA, you're not required to receive distributions, meaning you can put off your payouts, the Journal notes.

More for Your Heirs: Since Roth IRA funds are invested after tax, your heirs aren't taxed when your estate is passed on.

Related Links on MainStreet.com:

How to Roll Over Your 401(k) Into an IRA

Daily Deduction: Roth v. Traditional IRAs