Roth IRA: “One of the best deals in retirement planning”

With a Roth IRA, virtually all income growth and withdrawals are tax-free.  Because retirees don’t pay taxes on their withdrawals, the Roth IRA has been called one of the best deals in retirement planning.

With the turn of the New Year, the income limits that have prevented many individuals from converting a traditional IRA or employer-sponsored retirement plan to a Roth have been eliminated.   The loosening of the rules is particularly well-timed for a period when workers are losing their jobs and are no longer employed with the company that holds their retirement account.

There is a catch, though.  If you convert your traditional IRA or employer-sponsored retirement plan to a Roth IRA, you must pay taxes on the converted money as if it was earned income.

Even so, the Federal government has made this part less painful in 2010. You can report the amount you convert in 2010 on your tax return for that year. Or, you can spread the amount converted equally across your 2011 and 2012 tax returns, paying any resulting tax in those years. For example, if you convert $50,000 next year and choose not to declare the conversion on your 2010 return, you must declare $25,000 on your tax return for 2011 and $25,000 on you return for 2012. The two-year option is a one-time offer for 2010 conversions.

Many Roth IRA conversions may be subject to Measure 66′s higher rates

While most of the attention on Measure 66 has been directed at the impacts on entrepreneurs and investors, the increased taxes will also affect the thousands of middle class households that are considering a Roth IRA conversion.  Oregon’s Measure 66 will make such conversions especially painful because some or all of the money that investors have saved over the years may be subject to Measure 66′s highest tax rates.

Measure 66 imposes two new tax brackets affecting 2010 income:

• A new marginal tax rate of 10.8 percent would be levied for taxable income between $250,000 and $500,000 for joint filers and $125,000 and $250,000 for single filers.

• A new 11 percent marginal tax bracket would be created for taxable income above $500,000 for joint filers and $250,000 for single filers.

More than 40 percent of all families in the U.S. participate in some type of employment-based retirement plan.  These plans include defined benefit (pension) plans and defined contribution plans such as a 401(k) or 403(b).  In addition, approximately 1 in 3 families has an IRA or Keogh account.

Among those with either a defined contribution plan or an IRA/Keogh account, the average account balance is $148,440.  For those age 55 and older, the average account balance is more than $250,000.  More than 1 in 10 families have account balances in excess of $500,000.

A family converting $300,000 in retirement funds would have to come up with another $900 in Oregon taxes if subject to Measure 66.  A family converting a $600,000 retirement account would have to find another $6,500 in cash to pay additional Measure 66 taxes.

As an unintended consequence, Measure 66 may deny many Oregonians the chance to participate in a once-in-a-lifetime opportunity to get into what has been called one of the best deals in retirement planning.

The Wall Street Journal provides a summary of the provisions of the Roth IRA conversion program.  The Employee Benefit Research Institute provides statistics on retirement plans and balances in the plans.

When financial markets tanked earlier this decade, governments were facing huge increases in the amounts they would have to contribute to their employee’s PERS accounts to fill the defined benefit gap. The Oregon economy was in recession and the electorate had little or no tolerance for increased taxes. In response, the state and some local governments issued pension obligation bonds.

The plan carried some risks: While it would make high returns higher, it could make low returns disastrous. At the time, the stock market was about to begin a four-year run of double digit annual returns, the housing market was taking off and interest rates were nearing record lows. These factors caused state and local governments to determine that the benefits of issuing bonds outweighed the downside risks. The governments that used the bonds have moved themselves toward the back of the train, but they nevertheless remain on the train.

Read the entire op-ed at the Statesman-Journal, or download a PDF.

• Oregon’s per capita state and local expenditures almost doubled between the 1998-99 fiscal year and the 2004-05 fiscal year.  The most recent data from the Census shows expenditures of $8,060 per person.
• Oregon has the 11th highest state and local expenditures in the U.S. as a share of personal income.
• Oregon’s state and local expenditures are $2.8 billion higher than statistically predicted by its income and demographics.  That amounts to $776 per person.
• Oregon’s public employee pension system and insurance payments contribute to the higher spending.  Oregon’s spending on these items accounts for 12.5 percent of total state and local expenditures.  The average among all states is 8.3 percent.  Oregon’s spending on these items would be approximately $1 billion lower if it was “in line” with other states.

The most recent study, co-authored with Randall Pozdena and published by Cascade Policy Institute, is a follow-up to earlier studies published in 2002 and 2004.