Did you know that when you retire and take payments out a normal IRA, you pay tax on the normal tax rates? Did you also know that when you die, your heirs have to pay tax on any IRAs they inherit from you? Also, when you reach age 72, you MUST start taking out Required Minimum Distributions from a regular IRA, whether you need the money or not? Lastly, did you know there is a way to avoid all three of those situations? It’s called a ROTH IRA.
To convert a regular IRA to a ROTH IRA, you essentially pay up front all the taxes on the amount you convert to a ROTH in the year of conversion.
So, what exactly is a ROTH IRA? It comes down to the original tax impact of funds put into an IRA. If you got a tax deduction for the money you contributed to an IRA, then it is considered as a taxable IRA and all the above scenarios occur. If you contribute to an IRA and do NOT get a tax-deductible deduction for doing so, then it is a non-taxable IRA, usually officially called a ROTH IRA. A ROTH IRA grows tax deferred just like a regular IRA, BUT, you NEVER pay tax on any distributions.
The problem for many folks is, they have normal taxable IRAs. So how do they convert those taxable IRAs into non-taxable ROTH IRAs? Tell your IRA administrator you want to roll-over a certain amount of stock holdings from your taxable IRA into a ROTH IRA account. Your IRA administrator will issue you a form 1099-R at the end of the year, telling the IRS how much of your IRA distribution to your ROTH will be taxable in that year.
You then report that taxable amount of the IRA distribution on your tax return in the year of the roll-over.
Why do an IRA roll-over into a ROTH right now? Because the stock market is temporarily under water. If you rolled over a specific stock (without actually selling it) from your regular IRA into a ROTH IRA, when that stock goes back up in value, you will never pay tax on it.
Here is an example: Let’s say you hold $500,000 in certain stocks, but right now their market value has temporarily dropped to $300,000. If you converted that current fair market value stock holding from your taxable IRA to a ROTH, you would report and pay tax on $300,000. BUT, when the stock market recovers and those stocks go back up to $500,000, the $200,000 increase becomes TAX FREE!!!! (If you had converted those stocks from a taxable IRA to a ROTH when they were worth $500,000, you would have paid tax on $500,000.) Starting to see the “benefit” of a temporary drop in your IRA value due to market fluctuations?
Have you heard? Psalms 126:5 says, “Those who sow in tears shall reap with shouts of joy!”
Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 882-4459. On the web at BullisAndCo.com Also on Facebook.
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