Saturday, February 13, 2010

Don’t Let This Roth Conversion Tax-Trap Surprise You

Converting a traditional IRA or employer-sponsored retirement plan to a Roth IRA can make sense for many boomers. Once converted, you and your beneficiaries won’t ever have to worry about income taxes on the earnings and withdrawals. Plus you can kiss the required minimum distribution rule goodbye. And to make it better yet, this year the income restrictions have been lifted. So anyone, regardless of income, can do the conversion. Most people and their advisors know that when you convert, you’ll have to pay ordinary income tax on the pre-tax contributions and earnings converted. And if you convert an annuity, you’d probably assume that the conversion value would be the surrender or cash value. But you might be wrong … and you could get socked with some unexpected taxes. You see, your annuity might have guarantees that the IRS considers taxable. For example, a guaranteed minimum withdrawal benefit allows you to take out up to a certain amount every year — such as 5% or 6% of your initial investment — no matter how your investments perform or how long you live. Considering the hit the markets have taken since October 2007, these guaranteed benefits could be worth more than the cash value of the annuity. So before you convert your IRA or employer-sponsored plan to a Roth, make sure you understand what kind of assets you’re converting. And if you find an annuity among them, contact the issuing insurance company for the correct value so you won’t have a big surprise come tax time. Best wishes, George

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