Last Updated: May 25, 2009
Financial planning sometimes involves creative thinking. This may be the case if you're thinking about your parents and their retirement plans. With the stock market depressed and tax rates relatively low, financial planners say now might be a good time for older Americans to convert their traditional IRA to a Roth IRA.
This conversion comes with plenty of benefits. For instance, you aren't required to take a minimum distribution from a Roth IRA as you are with a traditional IRA. Beneficiaries of Roth IRAs do have to take a minimum distribution (or RMDs); however, the original owners do not have to take them. That means, Roth IRAs are often viewed as the perfect type of retirement account for estate planning purposes. In addition, owners of Roth IRAs can take tax-free distributions after age 59 ½. If younger than age 59½, owners can take tax-free distributions after owning the account for five or more years.
However, there are downsides to doing a Roth IRA conversion. Chief among them is you have to pay a tax on the distribution from the traditional IRA as part of the conversion process. The distribution is taxed at your ordinary income tax rate and in some cases, that could be a big check to cut. For instance, if you convert your $100,000 traditional IRA to a Roth IRA, you might owe $25,000 in federal taxes.
As such, financial planners suggest that now might be a good time to do a Roth IRA conversion. The market is still depressed relative to all-time highs. And taxes are still relatively low. That means, whatever you pay in taxes to do the conversion is likely to be low relative to what it could be in the future. What's more, in 2010, taxpayers with modified adjusted gross income of more than $100,000 will be allowed to convert a traditional IRA to a Roth IRA and the income taxes due on conversions can be spread over two years, 2011 and 2012.
But not everyone has the money to pay the tax bill due on a Roth IRA conversion, be this year or over the next three years. And that's where adult children might be able to play a role, say financial planners. In some cases, adult children might be able to help their parents and themselves out by paying the taxes due on the Roth IRA conversion. In some cases, that payment could be a loan, in other cases the payment could be a gift.
In either case, however, there are plenty of questions and complications that must be addressed before you loan or gift your parents money to convert their traditional IRA to a Roth IRA. And those complications and questions are best addressed with a financial planner. Find a financial planner.