A non-Traditional Gift...

As I do occasionally, I was checking the business headlines during my lunch break when I stumbled onto an article posted on Yahoo's Finance site. In it, the author (Suze Orman) explains a new tax law that creates a good opportunity for people saving for retirement (and we all should be in my opinion) to enhance their tax-free retirement savings.

Basically there are two types of retirement investments - those that will be taxable when you withdraw them in retirement and those that won't be. Now there are a litany of different investment vehicles that have all sorts of different rules and regulations attached to them - I won't even go there, it would take way too long and would eventually get beyond my own understanding.

While saving in traditional formats - the traditional IRA, 401(k), 403(b), etc. - generally have tax benefits up front (depending on your income level and tax filing status) by defering payment of income taxes on the money you're putting away until you withdraw it in retirement. That is a good thing and is generally more efficient than non-tax protected vehicles (depending on your income and future income outlook).

Experts (and yes, when it comes to this stuff I tend to rely on people who make this their business the same way I go to the doctor when I'm sick) tell me that even more valuable than the tax benefits that you get when you put money away tax free now only to pay the taxes later is money that you put away now (after taxes) that you'll never be charged tax on again. Yes, that's right, you'll never be taxed on it again. This is particularly the case when you expect to be in a higher tax bracket in retirement than you currently are (this tends to be the case for those of us just starting out) - because the taxes you would have paid now in the 10% bracket would be less than those you'll pay later in the ???% (perhaps 20% or more), not to mention that the earnings in a Roth IRA (specifically) are also tax protected.

The article explained a new tax law that takes effect in 2010 that allows people holding traditional IRAs to convert them to Roth IRAs. Basically, if you put money into a traditional IRA you would have to pay taxes on the earnings in that account from the time it was put in until the date you were converting it to the Roth version. After that, you'd have no tax liability on the principle or the interest in that account.

This new law offers some opportunities both for the lower/middle wage earners as well as high income people.

For those of us filing tax returns that qualify to deduct our IRA contributions (there is a point at which you can't do that anymore, which she explains) from our yearly filings and receive the tax benefit thereof, we can then later convert those accounts to Roth accounts - which will avoid paying any further taxes on the account (after taxes on the earnings are paid). Depending on what the markets do in the next 4 years this could be a small win or a huge win.

For those in upper income brackets who are currently not elgible to contribute to Roth IRAs (at a certain income level people aren't currently allowed to use this investment vehicle) this offers a chance to invest in traditional IRAs and then later convert them to a Roth. This represents an indirect method of obtaining the coveted non-taxable retirement income, but is an opportunity the high income earners don't currently have.

There are also some other rules and stipulations about conversion timing and tax burden payment. The article explains things fairly well and will definitely prompt me to ask some questions about this option with my financial advisor to see if it would benefit Brittany and I.

One other thing to note. With Roth IRAs you are not required to pull the money out at a certain age (only to have it in there 5 years before you touch it), whereas with the Traditional IRA you must start drawing it out by age 70 and 1/2. This means that if you found yourself so blessed as to not need to draw some of your investment money out in retirement it could be left in that Roth account until your heirs inherited it or even until you donated it to a worthy charity or ministry (like CIY).