Latest Rules Covering Roth IRAs

With Democrats now running the show in Washington, it is hard to say what will happen with the tax-advantaged Roth account. Former President George Bush signed the Tax Increase and Reconciliation Act of 2005 into law, which gives individuals two years to pay down tax liabilities for next year's conversions. However, the Roth hasn't been a popular retirement vehicle among Democrats. The Obama administration will make certain to increase tax revenues as a means to paying down the deficit; therefore, it's hard to say what new Roth provisions could surface over the next year.

A looming trillion-dollar deficit for the Obama administration means investment taxes will presumably go up. The question is, how much? President Obama floated around the idea of capital gains increasing to 20 or 28 percent during his presidential campaign, albeit other liberals would prefer investment income to be congruent with labor income taxes. What does this mean for anyone considering a conversion? Expect a potentially higher tax liability under the Obama administration and discuss with your tax adviser how this tax hike could impact your financial strategy in regards to Roth conversions.

Presuming conversion requirements aren't changed by the Obama administration, many investors will finally have access to the Roth account via conversion. The power of compounding tax-free earnings, untapped by Uncle Sam, offers a huge advantage over tax-deferred accounts. Roth owners end up with more money at retirement (which liberals would love to tax) due to the compounding effect of their earnings, which traditional IRA owners lose by deferring taxes to the back-end.

Why should an individual pay more taxes through conversion, if he believes he'll be in a lower tax bracket at retirement? Many people are of the opinion that our income tax will go up under the Obama administration; therefore, locking in your tax rate by converting next year and spreading out your tax liability over the following two years is potentially a better tax deal. Furthermore, no required minimum distributions requirements are extremely beneficial when it comes to estate planning for individuals leaving their Roth to their heirs--beneficiaries benefit from a substantial time period of compounded tax-free earnings growth, all untapped by Uncle Sam.

Whilst this latest conversion rule is slated to transpire next year, no one knows for sure whether it will actually take place. The House Committee on Education and Labor are openly discussing doing away with the 401k plans entirely for a mandatory pension plan overseen by the government (though nothing has been drafted or voted on at this time). This could pave the way to abolishing tax advantages derived from accounts like the Roth as well. There is a risk in converting if the new administration puts new laws into effect. However, even if this happens, locking in a lower tax rate now is better if you believe income tax hikes are on the horizon.