New Year's Resolution: Roth Rollover

George Young, porfolio manager of the Villere Balanced Fund (VILLX), weighs the benefits of a Roth conversion. The views expressed here are his own.

For the past few months, political events have dominated the market’s attention. Between elections and the fiscal cliff, it is no wonder that some investors feel that their portfolios are subject to factors beyond their control. But investors should not lose sight of the issues they do have control over.

Amid the questions about tax rates, fate of the estate tax and Social Security, there are plenty of investing options available. One of these is IRA contributions and maximizing the value of an IRA via a Roth IRA conversion.

Here’s a simple suggestion: for many, the end of the year may be a great time to convert a traditional IRA or a rollover IRA to a Roth IRA. A Roth conversion is a tactic that many high net worth investors can take advantage as an estate and retirement planning strategy.

Benefits & Drawbacks Of A Roth Conversion
First, two pieces of good news:
1. The funds in a Roth IRA will grow tax- free (not tax-deferred as in a Traditional or Rollover IRA). That means that if and when you take a distribution from a Roth IRA in retirement, you will not owe any taxes. That’s different than with a traditional IRA or a rollover IRA, where you must pay taxes at your ordinary income rate at the time of a distribution.
2. A Roth IRA may also be a great tax and estate planning tool since you don’t have to take a Required Minimum Distribution, potentially leaving more to your heirs. With a traditional or rollover IRA, you must take a Required Minimum Distribution whether you need the money or not beginning at age 70 and a half.

Then, the bad news:
You may have to pay some taxes to effect a conversion to a Roth IRA. But 2012 may be the year to do it if you happen to be closing a bleak income year or, as we believe is likely, you are concerned that taxes will rise next year.

Taxes will be owed because you most likely claimed a tax deduction on contributions you made to your rollover or traditional IRA. To get a handle on the potential tax bill associated with a Roth conversion, consult your tax advisor.

Other Roth Benefits
There are other benefits for a Roth IRA versus a traditional or rollover IRA. Because Roth assets aren’t taxable or subject to required minimum distributions in retirement, they may minimize your tax bill and potentially keep Medicare premiums down, which are based on income.

In addition, if your heirs inherit a Roth IRA, they will have to take funds out of it every year, however they won’t have to pay taxes on those distributions.

Here’s another thought: many high net worth investors have non-deductible IRAs because their income exceeded IRA deductibility limits. So if you have non-deductible IRAs, those are less expensive in terms of taxes to convert because part of the conversion will not be subject to taxes. However, the IRS has complex rules about converting some IRA assets but not all, so consult a tax advisor.

Another option for investors who have 401(k) assets from former employers is to roll those assets over into a traditional IRA. Once those assets are in a traditional IRA, they are eligible for a Roth conversion.

If you decide in favor of a Roth conversion, most tax advisors agree that it makes the most sense to pay the taxes due on the conversion from assets you have outside of your traditional or rollover IRA account. So if you lack the funds to pay that tax bill, it may not make sense to do a Roth conversion. That’s because if you take funds from your traditional or rollover IRA to pay those taxes, you may have to pay additional taxes on those funds when you withdraw them and they will not be available when you retire.

Annual IRA Contributions
Regardless of whether you decide in favor of converting IRA assets to a Roth, don’t forget to make a contribution to your IRA (Roth or Traditional). Remember that you have until April 15, 2013 to make a 2012 contribution but the earlier you make it, the earlier it will begin working for you.

If you have the cash, also consider making your 2013 contribution as early in the year as possible. In 2013, IRA contribution limits will increase from $5,000 to $5,500. If you are age 50 or over, the IRS permits you to make catch-up contributions, which is an additional $1,000, unchanged from 2012. These additional contributions may significantly add to your retirement assets over time.

A Final Word
A Roth IRA conversion is an important retirement and estate planning tool that is very useful for high net worth individuals. Whether you take that step in 2012 or 2013, consider it seriously as there may be very real benefits for you and your heirs.

George Young is the co- portfolio manager of the Villere Balanced Fund (VILLX), based in New Orleans.  The fund received a 5 star Overall Morningstar Rating among 771 Moderate Allocation Funds for the period ending 9/30/2012 (derived from a weighted average of the fund’s three-, five- and ten-year risk adjusted return measure, if applicable) . The fund ranked in the top 2% for 1-year among 892 funds, 1% for 3-years among 771 funds, 1% for 5-years among 670 funds and 1% for 10-years among 381 funds in the Moderate Allocation category based on total returns for the period ending 9/30/2012.

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