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Evan
11-28-2009, 10:53 AM
If you have a tax-deferred account, such as a traditional IRA, there is generally no way to benefit from capital losses. But, you may be able to receive SOME benefit if eligible to convert to a Roth IRA.

For example, if you are in the 25% tax bracket and contributed $100,000 to a traditional IRA, you received tax benefits of approximately $25,000 (that is, reduced your tax bill over the years by $25,000, cumulatively). If the fair value of your traditional IRA, with losses, is now $70,000, and you are eligible to convert to a Roth IRA, your total tax bill would be $17,500 (at a 25% rate).

Why would you want to pay $17,500 now? With such depressed markets, and if you can assume that the market increases (depending on your investing strategy), you can make tax-free withdrawals beginning at 59-1/2 and after 5 years of having the account open. (There are exceptions to 59-1/2, like the traditional IRA, that would permit you to withdraw sooner.)

Can I convert? In 2009, you must have a modified adjusted gross income of $100,000 on a single or joint return in order to contribute. Keep in mind that when converting, your AGI increases for every dollar you withdraw. The good news? After 2009, there is no income limitation after 2009. So if you don't qualify now, you will next year! But don't wait too long, because after 2010, the Bush tax cut expires, and your effective tax rate may be higher than it is today.

Speak to your accountant or a retirement specialist to see if converting your tax-deferred account to a Roth IRA makes sense. Converting is not for everyone, and should be analyzed using your specific life and financial situation.

vangogh
11-28-2009, 04:51 PM
Thanks for the info Evan. I'm not 100% sure, but is the main advantage of the Roth IRA the lack of withdrawal penalties for an early withdrawal?

Evan
11-28-2009, 05:04 PM
Is the main advantage of the Roth IRA the lack of withdrawal penalties for an early withdrawal?

No. The main advantage should be that you have tax-free growth. So if you invested $100,000 and put it in risky stocks and earned a lot of money -- once you reach 59-1/2, all of it is tax-free. Most people do the complete opposite and put speculative investments in taxable accounts. Then you end up with paying capital gains.

Let's say you invest $10,000 and had $5,000 of growth. If you do not have a qualified withdrawal, you are able to withdraw the $10,000 (your contributions) without penalty. The remaining $5,000 is subjected to the 10% penalty.

The good news is if you withdraw just $2,000 -- you don't need to "guess" what is what. Withdrawals are made in the following order: contributions to the Roth IRA, conversion contributions (aka IRA to Roth, etc.), and finally earnings. You can withdraw your contributions without penalty.

vangogh
11-29-2009, 01:27 AM
Thanks. I think I understand now.