Roth IRAs. Plan for 2013 Today

With all the buzz of Roth conversions, there are some additional items to consider that have become law during 2010. One of these is the 3.8% investment tax set to take effect in 2013. It might seem bizarre to be planning for something that does not become law until 2013, but converting a traditional IRA to a Roth IRA in 2010 could provide some benefits.

One benefit of a Roth is there are no required minimum distributions (RMD) in future years. If the money is left in a traditional IRA then the RMDs will increase modified adjusted gross income (MAGI). Once this reaches $250,000 for a married couple the 3.8% tax kicks in.

See the following example to get a better idea of how this would work:

Client A is married and has total income of $200,000 all of it investment income in 2013. None of this would be subject to the 3.8% tax since it is under threshold. Assume though that in 2014 client has to take a RMD of $125,000. In this case they now incur the 3.8% tax on $75,000. ($200,000+$125,000 = $325,000) ($325,000-$250,000 = $75,000)

Even though the RMD itself is not subject to the 3.8% it increases the income enough to cause the client to be above the threshold. Thus additional tax is incurred on the investment income over the threshold.