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Posted: June 22, 2009

Tax relief for everyone

Roth IRA is simple way to save money and reduce taxes

Wayne Farlow

There is a simple, easy-to-use tax reduction tool, currently available to 90 percent of all US taxpayers. In 2010, this tool will be available to everyone.  Unfortunately, only 19 percent of all taxpayers currently take advantage of it. Do you know what it is?

If you guessed the Roth IRA, you’re correct. Like a traditional IRA, a Roth IRA is a personal savings account in which funds grow tax free. Unlike a traditional IRA, when Roth IRA funds are withdrawn, in a qualified withdrawal, no taxes are due on either the funds or their investment growth.
With the growing federal deficit, it is probably safe to assume that your tax bracket in retirement will be close to your present tax bracket. If so, the Roth IRA will always yield a higher after-tax return than a traditional IRA. This holds true even when if you invest the tax savings from your traditional IRA contribution.   

Another advantage of a Roth IRA is that there are no mandatory distribution requirements. With a traditional IRA or a 401(k) plan, you must begin taking withdrawals and paying taxes on the withdrawn funds at age 70 ½, even if you do not need these funds. Because there are no mandatory withdrawal requirements with a Roth IRA, they can be an excellent estate planning tool. If you do not need your Roth IRA funds during retirement, the Roth IRA funds can be passed to your heirs. The inherited Roth IRA funds remain income tax free when withdrawn by your heirs. An inherited Roth can have a mandatory distribution schedule that is based on the expected lifetime of the heir. This allows most of the Roth IRA funds to continue to grow tax free throughout a second lifetime.
If you earn less than $105,000 as an individual tax filer or less than $166,000 as a joint filer, you can annually contribute up to $5,000 ($6,000 if age 50 or over) to a Roth IRA, even if you are covered by a qualified company retirement plan.
Many financial advisors recommend that you put the maximum amount possible into a tax-deferred retirement account, such as a 401(k) or 403(b). However, it is often wiser to put the maximum amount that your company will match in the tax-deferred retirement account and put the next $5,000 ($6,000 if age 50 or over) of retirement savings into a Roth IRA. This approach will maximize your after tax retirement funds and maximize your withdrawal options during retirement.

Converting tax deferred funds from a traditional IRA or 401(k) to a Roth IRA is often wise, especially if you may not need all of your tax deferred funds during retirement. Currently, if your annual income (AGI) exceeds $100,000, this type of conversion is not permitted. However, this income limitation for a Roth IRA conversion will soon disappear.  

Starting in 2010, everyone will be able to do a Roth IRA conversion, regardless of income level. With a Roth IRA conversion, you must pay current taxes on the amount converted. Once these funds are converted, you never pay income taxes on these funds and their investment gains again. There is an additional incentive to convert funds to a Roth IRA in 2010. Taxes owed on funds converted in 2010 can be spread over two tax years. In 2011 and beyond, 100 percent of the conversion taxes must be paid in the year of the conversion.

A Roth IRA conversion should only be considered if you have adequate additional savings to pay the taxes due without using the converted funds.  If you will need any of the converted funds within five years, do not convert these funds. Funds withdrawn within five years will likely be considered a non-qualified distribution, requiring the payment of a 10 percent penalty on any funds withdrawn.

With the enormous expansion of government debt, it seems likely that income and capital gain tax rates will soon rise. Whether you are eligible now, or must wait until 2010, the benefits of having a Roth IRA should be considered as part of your personal financial plan.

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Wayne Farlow is the founder of Financial Abundance, LLC, a Registered Investment Advisor firm.  He is a Certified Financial Planner (CFP®), focusing on Retirement Planning, Investment Management, Small Business Owner Planning and Sudden Wealth/Inheritance Planning.  His book, “Financial Abundance Guide,” is available free at .  He can be reached at or at 303-554-0309.

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