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Smart Move: Roth IRA Conversion When You're Jobless

December 4th, 2009 at 01:04 am



Being out of work can be a daunting experience that's mostly filled with anxious questions about how you're going to pay the mortgage and your many day-to-day expenses.

While the good things one can say about how unemployment affects your finances are few and far between, there is at least one positive scenario you should take advantage of if you've been out of work for more than a few months: a Roth IRA conversion.

For most investors, Roth IRAs have long been recognized as a preferable alternative to traditional IRAs, due to their tax treatment.

With a Roth IRA, you don't get a tax break when you make contributions, but after age 59 1/2, all your withdrawals, including accumulated earnings, can be taken tax-free.

In contrast, all or a part of your contributions to a traditional IRA may be tax deductible, which could lower your taxes. You will be taxed, however, on withdrawals, and your tax rate will vary according to what tax bracket you fall in at the time of withdrawal.

While you must take minimum distributions from a traditional IRA by age 70 1/2, there is no such requirement associated with Roth IRA withdrawals, making them an ideal tool not only for retirement, but for passing assets on to heirs.

Many workers believe their tax bracket upon retirement will be higher than in their earlier working years, making Roth IRA conversions an attractive option.

Yet the stumbling block for some has been the sizable tax bill that can often come due from such a conversion, since the amount converted is added to your income and is subject to tax.

That's why long-term unemployment or underemployment can make a Roth IRA conversion a much more doable event with a much less painful tax bite.

In my case, I was laid off in September 2009, so I will still have significant 2009 income to report when I do my taxes. But given the extraordinarily poor job market, it's conceivable I'll remain unemployed for much of 2010; what income I do earn, aside from unemployment benefits, may come from freelance writing or other temporary work assignments.

If that's the case, or for others who have already been out of work for much of 2009, this could be an ideal time to take advantage of your lower tax bracket during this time and convert your IRA to a Roth IRA. The conversion could cost you very little.

In my own case, I've been wanting to convert at least a portion of my traditional IRAs into Roth IRAs for some time, but the subsequent tax bill made me reluctant to do more than think about it. If my unemployment continues well into next year, however, my income will be abnormally low and I could fall into a lower tax bracket.

Remember when calculating your total income to include any unemployment benefits you may be receiving.

A Roth IRA conversion now might still make sense for you, even if you've only been out of work for a few months. If, for example, your salary when you were employed placed you close to the minimum income within any of the federal tax brackets. In a case like this, even a small reduction of income could bump you into a lower bracket.

Remember, you can only convert to a Roth IRA if your modified adjusted gross income is under $100,000 in 2009. And this limit on income disappears next year.

Consider such a tax-advantageous move only if you have adequate savings and won't hurt yourself by paying the IRA conversion tax bill. But then again, if your only income is unemployment benefits or sporadic, part-time work, the tax bill could be pretty manageable.

Please consult a certified finance planner or tax professional to determine whether a Roth IRA conversion is suitable for your needs.

12 Responses to “Smart Move: Roth IRA Conversion When You're Jobless ”

  1. davera Says:

    Fern, you are an excellent writer! Nice job on this post and very good info.

  2. Analise Says:

    Excellent information... very clearly presented. Thanks!

  3. baselle Says:

    Interesting idea. But really be careful - generally taxes are not taken out of unemployment and its taxable income. The combo of paying taxes on both unemployment and the Roth conversion can really kill you if you aren't prepared.

  4. creditcardfree Says:

    I'm planning to do some Roth conversions next year, too. My husband will be deployed to combat zone making more than half our income for the year untaxable. This allows us to change tax brackets and convert a reasonable sum of money with little, if any, effect on our taxes.

    Great post!

  5. fern Says:

    Baselle, yes, I'd want to make sure the taxes were reasonable. In Connecticut where I live, you're able to choose to have taxes taken out - or not - when you start to receive benefits. In my case, I gross $519 a week. They take out $52 for federal taxes and $15 for state taxes.

    I'd never want to be stuck with paying a big tax bill at tax time, especially if there was a chance I was still out of work at that time. So I find it better to deal with the smaller net benefits checks throughout the year.

  6. fern Says:

    Creditcardfree, I had no idea that combat pay was not taxable. Thanks for pointing out another large group of people who could benefit from Roth IRA conversions at this time. I hope your husband and all the troops return home safely, and soon.

  7. financeaholic Says:

    beautifully written! thanks for the information Smile

  8. LuxLiving Says:

    We just completed converting Hubster's as he has been unemployed since January of this year.

  9. ImInSameBoat Says:

    I also lost my job in Sept 2009 and expect to be out most of 2010. I read an interesting article on the Fidelity.com web site tonight about Roth conversions. Essentially, if the value of the IRA goes down at the time of the conversion you will save on taxes due but we do not know if stocks will go up or down. So you can make the conversion now then if stocks fall later in the year you can recharacterize the IRA back to a traditional IRA and re-do the Roth conversion at the lower tax point. This gives some insurance on the transaction.

  10. DR Says:

    I was not employed nor did I receive any government susistence for 2009. Am I to understand that my Roth Conversion would put me in the lowest tax bracket of ? (10%?) if no reportable income?

  11. Fern Says:

    DR, which federal tax bracket you'll fall into depends on the total income earned this year, whether in the form of compensation from an employer, unemployment benefits or investment earnings.

    If you have earned none of the above in 2010 (not 2009), it would appear you would fall into the 10% federal tax bracket. The upper limit of that tax bracket is $8,375 for single filers and $16,750 for married couples filing jointly.

    Be aware that the amount you convert is itself considered income, so if you decided to convert $50,000, that would bump you into a higher tax bracket.

  12. tari Says:

    Savvy suggestions , BTW , if your business needs a EA 741-E , We filled out and faxed a template document here "http://pdf.ac/9wVo9d"

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