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Tax Bill: Roth IRA Conversions Equivalent to 'Interest-Free Loans'

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The extension of current income-tax rates gives wealthy taxpayers the equivalent of an interest-free loan if they convert a regular individual retirement account to a Roth IRA by Dec. 31.

Bloomberg reports investors in traditional IRAs pay taxes up front on conversions to Roth IRAs to get tax-free withdrawals later. As Bloomberg notes, earners in the highest tax brackets who expected rates to rise next year were faced with reporting all the additional income from conversions on their 2010 returns. With the tax legislation, wealthy savers can now defer and use those tax dollars to earn something.

“It’s the deal of the century,” Ed Slott, founder of website told Bloomberg. “It’s like Congress is giving you an interest-free loan to build a tax-free savings account.”

This year taxpayers can choose to report the taxable income from the conversion in 2010, or split it equally between 2011 and 2012. Federal income-tax rates were set to rise in 2011 to as high as 39.6%, up from 35%, when tax cuts instituted by President George W. Bush were to expire.

The Senate passed an $858 billion tax cut plan Dec. 15 that would keep existing income tax rates for all earners through 2012. The House voted 277-148 for final passage even though many House Democrats wanted to limit the tax cut extension to the first $250,000 of family income. President Barack Obama signed the measure into law Dec.17.

That means a taxpayer in the top income bracket with an IRA worth $1.2 million would likely pay 35% or $420,000 in federal taxes when converting the entire account to a Roth IRA this year, according to the story. They would have paid $475,200 if income tax rates had increased in 2011 to 39.6%, or $55,200 more in taxes.


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