Roth IRA Conversions--New Opportunities for Roth IRA Conversions--New Opportunities for 20102010

With the lure of tax-free distributions, Roth IRAs With the lure of tax-free distributions, Roth IRAs have become popular retirement savings have become popular retirement savings

vehicles since their introduction in 1998. But if vehicles since their introduction in 1998. But if you're a high-income taxpayer, chances are you you're a high-income taxpayer, chances are you

haven't been able to participate in the Roth haven't been able to participate in the Roth revolution. Well, new rules apply in 2010 that revolution. Well, new rules apply in 2010 that

may change all that.may change all that.

What are the general rules for funding Roth What are the general rules for funding Roth IRAs?IRAs?

There are three ways to fund a Roth IRA--you can There are three ways to fund a Roth IRA--you can contribute directly, you can convert all or part of contribute directly, you can convert all or part of

a traditional IRA to a Roth IRA, or you can roll a traditional IRA to a Roth IRA, or you can roll funds over from an eligible employer retirement funds over from an eligible employer retirement

plan (more on this third method later).plan (more on this third method later).

In general, you can contribute up to $5,000 to an In general, you can contribute up to $5,000 to an IRA (traditional, Roth, or a combination of both) IRA (traditional, Roth, or a combination of both)

in 2010. If you're age 50 or older, you can in 2010. If you're age 50 or older, you can contribute up to $6,000 in 2010. (Note, though, contribute up to $6,000 in 2010. (Note, though,

that your contributions can't exceed your earned that your contributions can't exceed your earned income for the year.)income for the year.)

But your ability to contribute directly to a But your ability to contribute directly to a Roth IRA depends on your income level Roth IRA depends on your income level ("modified adjusted gross income," or ("modified adjusted gross income," or MAGI), and is phased out as s shown MAGI), and is phased out as s shown below:below: Single or head of household More than $120,000 Single or head of household More than $120,000 Married Filing Jointly More than Married Filing Jointly More than $160,000 Married Filing Single$160,000 Married Filing Single

More than $10,000 More than $10,000

What's changed?What's changed?Prior to 2010, you couldn't convert a traditional Prior to 2010, you couldn't convert a traditional IRA to a Roth IRA (or roll over non-Roth funds IRA to a Roth IRA (or roll over non-Roth funds

from an employer plan to a Roth IRA) if your MAGI from an employer plan to a Roth IRA) if your MAGI exceeded $100,000 or you were married and filed exceeded $100,000 or you were married and filed

separate federal income tax returns.separate federal income tax returns.In 2006, however, President Bush signed the Tax In 2006, however, President Bush signed the Tax

Increase Prevention and Reconciliation Act Increase Prevention and Reconciliation Act (TIPRA) into law. TIPRA repealed the $100,000 (TIPRA) into law. TIPRA repealed the $100,000

income limit and marital status restriction, income limit and marital status restriction, beginning in 2010. What this means is that, beginning in 2010. What this means is that,

regardless of your filing status or how much you regardless of your filing status or how much you earn, you can now convert a traditional IRA to a earn, you can now convert a traditional IRA to a Roth IRA. (There's one exception--you generally Roth IRA. (There's one exception--you generally can't convert an inherited IRA to a Roth. Special can't convert an inherited IRA to a Roth. Special

rules apply to spouse beneficiaries.)rules apply to spouse beneficiaries.)

And don't forget your SEP IRAs and SIMPLE IRAs. And don't forget your SEP IRAs and SIMPLE IRAs. They can also be converted to Roth IRAs (for They can also be converted to Roth IRAs (for

SIMPLE IRAs, you'll need to participate in the plan SIMPLE IRAs, you'll need to participate in the plan for two years before you convert). You'll need to for two years before you convert). You'll need to

set up a new SEP/SIMPLE IRA to receive any set up a new SEP/SIMPLE IRA to receive any additional plan contributions after you convert.additional plan contributions after you convert.

What hasn't changed?What hasn't changed? TIPRA did not repeal the income limits that TIPRA did not repeal the income limits that may prevent you from making annual Roth may prevent you from making annual Roth contributions. But if your income exceeds contributions. But if your income exceeds these limits, and you want to make annual these limits, and you want to make annual

Roth contributions, there's an easy Roth contributions, there's an easy workaround. You can make nondeductible workaround. You can make nondeductible contributions to a traditional IRA as long as contributions to a traditional IRA as long as you have earned income at least equal to you have earned income at least equal to

the contribution, and you haven't yet the contribution, and you haven't yet reached age 70½. reached age 70½.

You can simply make your annual contribution You can simply make your annual contribution first to a traditional IRA, and then take first to a traditional IRA, and then take

advantage of the new liberal conversion rules advantage of the new liberal conversion rules and convert that traditional IRA to a Roth. and convert that traditional IRA to a Roth. There are no limits to the number of Roth There are no limits to the number of Roth conversions you can make. (You'll need to conversions you can make. (You'll need to

aggregate all of your traditional IRAs when you aggregate all of your traditional IRAs when you calculate the taxable portion of the calculate the taxable portion of the conversion--more on that below.)conversion--more on that below.)

Calculating the conversion taxCalculating the conversion tax When you convert a traditional IRA to a Roth IRA, When you convert a traditional IRA to a Roth IRA, you're taxed as if you received a distribution with you're taxed as if you received a distribution with

one important difference--the 10% early one important difference--the 10% early distribution tax doesn't apply, even if you're distribution tax doesn't apply, even if you're under age 59½. (The IRS may recapture this under age 59½. (The IRS may recapture this

penalty tax, however, if you make a nonqualified penalty tax, however, if you make a nonqualified withdrawal from your Roth IRA within 5 years of withdrawal from your Roth IRA within 5 years of

your conversion.)your conversion.)

If you've made only nondeductible (after-tax) If you've made only nondeductible (after-tax) contributions to your traditional IRA, then only the contributions to your traditional IRA, then only the earnings, and not your own contributions, will be earnings, and not your own contributions, will be

subject to tax at the time you convert the IRA to a subject to tax at the time you convert the IRA to a Roth. But if you've made both deductible and Roth. But if you've made both deductible and

nondeductible IRA contributions to your nondeductible IRA contributions to your traditional IRA, and you don't plan on converting traditional IRA, and you don't plan on converting the entire amount, things can get complicated.the entire amount, things can get complicated.

That's because under IRS rules, you can't just That's because under IRS rules, you can't just convert the nondeductible contributions to a Roth convert the nondeductible contributions to a Roth and avoid paying tax at conversion. Instead, the and avoid paying tax at conversion. Instead, the amount you convert is deemed to consist of a amount you convert is deemed to consist of a pro-rata portion of the taxable and nontaxable pro-rata portion of the taxable and nontaxable

dollars in the IRA.dollars in the IRA.For example, assume that your traditional IRA For example, assume that your traditional IRA

contains $350,000 of taxable (deductible) contains $350,000 of taxable (deductible) contributions, $100,000 of taxable earnings, and contributions, $100,000 of taxable earnings, and

$50,000 of nontaxable (nondeductible) $50,000 of nontaxable (nondeductible) contributions. You can't convert only the $50,000 contributions. You can't convert only the $50,000

nondeductible (nontaxable) contributions to a nondeductible (nontaxable) contributions to a Roth, and have a tax-free conversion. Instead, Roth, and have a tax-free conversion. Instead,

you'll need to prorate the taxable and nontaxable you'll need to prorate the taxable and nontaxable portions of the account. So in the example above, portions of the account. So in the example above,

90% ($450,000/$500,000) of each distribution 90% ($450,000/$500,000) of each distribution from the IRA in 2010 (including any conversion) from the IRA in 2010 (including any conversion)

will be taxable, and 10% will be nontaxable.will be taxable, and 10% will be nontaxable.

You can't escape this result by using separate You can't escape this result by using separate IRAs. Under IRS rules, you must aggregate all of IRAs. Under IRS rules, you must aggregate all of

your traditional IRAs (including SEPs and SIMPLEs) your traditional IRAs (including SEPs and SIMPLEs) when you calculate the taxable income resulting when you calculate the taxable income resulting from a distribution from (or conversion of) any of from a distribution from (or conversion of) any of

the IRAs.the IRAs.

Special deferral rule for 2010 conversions Special deferral rule for 2010 conversions onlyonly

But even if you have to pay tax at conversion, But even if you have to pay tax at conversion, TIPRA contains more good news--if you make a TIPRA contains more good news--if you make a

conversion in 2010, you can take advantage of a conversion in 2010, you can take advantage of a special deferral rule that applies only to 2010 special deferral rule that applies only to 2010

conversions. You can report half the income from conversions. You can report half the income from the conversion on your 2011 tax return and the the conversion on your 2011 tax return and the

other half on your 2012 return. Or you can other half on your 2012 return. Or you can instead elect to report all of the income from the instead elect to report all of the income from the

conversion on your 2010 tax return.conversion on your 2010 tax return.

For example, if your only traditional IRA contains For example, if your only traditional IRA contains $250,000 of taxable dollars (your deductible $250,000 of taxable dollars (your deductible

contributions and earnings) and you convert the contributions and earnings) and you convert the entire amount to a Roth IRA in 2010, you can entire amount to a Roth IRA in 2010, you can

report half of the resulting income ($125,000) on report half of the resulting income ($125,000) on your 2011 federal tax return, and the other half your 2011 federal tax return, and the other half

($125,000) on your 2012 return. Or you can ($125,000) on your 2012 return. Or you can instead report the entire $250,000 on your 2010 instead report the entire $250,000 on your 2010

tax return.tax return.

Should you use the special 2010 deferral rule? Should you use the special 2010 deferral rule? The answer depends in part on your tax rate in The answer depends in part on your tax rate in

2010 versus what you think your tax rates will be 2010 versus what you think your tax rates will be in 2011 and 2012. Keep in mind that tax rates are in 2011 and 2012. Keep in mind that tax rates are

scheduled to increase in 2011, if the Bush tax scheduled to increase in 2011, if the Bush tax cuts are allowed to expire. The top tax rate will cuts are allowed to expire. The top tax rate will

increase to 39.6% in 2011, up from 35% in 2010.increase to 39.6% in 2011, up from 35% in 2010.

And speaking of employer retirement And speaking of employer retirement plans...plans...

You can also roll over non-Roth funds from an You can also roll over non-Roth funds from an employer plan (like a 401(k)) to a Roth IRA. Prior employer plan (like a 401(k)) to a Roth IRA. Prior

to 2010, the income limits and marital status to 2010, the income limits and marital status restrictions also applied to employer plan restrictions also applied to employer plan

rollovers to Roth IRAs (commonly referred to as rollovers to Roth IRAs (commonly referred to as conversions). As with traditional IRA conversions, conversions). As with traditional IRA conversions, these restrictions have been removed beginning these restrictions have been removed beginning

in 2010, and now anyone can roll over funds from in 2010, and now anyone can roll over funds from an employer plan to a Roth, regardless of income an employer plan to a Roth, regardless of income

level or marital status.level or marital status.

Like traditional IRA conversions, the amount you Like traditional IRA conversions, the amount you convert will be subject to income tax in the year convert will be subject to income tax in the year

of conversion (except for any after-tax of conversion (except for any after-tax contributions you've made). But the good news is contributions you've made). But the good news is

that the special deferral rule discussed earlier that the special deferral rule discussed earlier also applies to amounts you roll over from an also applies to amounts you roll over from an employer plan to a Roth IRA in 2010. You can employer plan to a Roth IRA in 2010. You can report half of the conversion income on your report half of the conversion income on your

2011 tax return, and the other half on your 2012 2011 tax return, and the other half on your 2012 return, or you can instead elect to report all of return, or you can instead elect to report all of the income on your 2010 tax return. And even the income on your 2010 tax return. And even non-spouse beneficiaries can roll over inherited non-spouse beneficiaries can roll over inherited

employer plan funds to a Roth IRA, as long as it's employer plan funds to a Roth IRA, as long as it's done in a direct (not 60-day) rollover.done in a direct (not 60-day) rollover.

And don't forget--if you make a Roth conversion And don't forget--if you make a Roth conversion and it turns out not to be advantageous (for and it turns out not to be advantageous (for

example, the value of your investments declines example, the value of your investments declines substantially), IRS rules allow you to "undo" the substantially), IRS rules allow you to "undo" the conversion. You generally have until your tax conversion. You generally have until your tax

return due date (including extensions) to undo, or return due date (including extensions) to undo, or "recharacterize," your conversion. For most "recharacterize," your conversion. For most

taxpayers, this means you have until October 15, taxpayers, this means you have until October 15, 2011, to undo a 2010 Roth conversion.2011, to undo a 2010 Roth conversion.

Recharacterization Recharacterization If converting large dollar amount of IRA, consider If converting large dollar amount of IRA, consider converting to multiple Roth IRAs based on asset converting to multiple Roth IRAs based on asset

class.class.

This allows one to recharacterize select Roth This allows one to recharacterize select Roth Conversion IRAs based on how the investments Conversion IRAs based on how the investments

perform.perform.

Paperwork is very intensive when using this type Paperwork is very intensive when using this type of strategy.of strategy.

Is a Roth conversion right for you?Is a Roth conversion right for you? The answer to this question depends on The answer to this question depends on many factors, including your current and many factors, including your current and

projected future income tax rates, the projected future income tax rates, the length of time you can leave the funds in length of time you can leave the funds in the Roth IRA without taking withdrawals, the Roth IRA without taking withdrawals, your state's tax laws, and how you'll pay your state's tax laws, and how you'll pay the income taxes due at the time of the the income taxes due at the time of the

conversion.conversion. A financial professional can help you decide A financial professional can help you decide

whether a Roth conversion is right for you, and whether a Roth conversion is right for you, and whether you should take advantage of the special whether you should take advantage of the special

deferral rule for 2010 conversions.deferral rule for 2010 conversions.

Prepared by Forefield Inc. Copyright 2010Prepared by Forefield Inc. Copyright 2010..

When are Roth Conversions AdvantageousWhen are Roth Conversions Advantageous

When other tax events generate tax losses that can be When other tax events generate tax losses that can be used to offset the additional income from the conversion used to offset the additional income from the conversion

(i.e. medical deductions exceeding taxable income.(i.e. medical deductions exceeding taxable income.

When you want to leave a tax free legacy to someoneWhen you want to leave a tax free legacy to someone

When you are confident that you tax rate will go up in the When you are confident that you tax rate will go up in the futurefuture

When you want to reduce your future estate by paying When you want to reduce your future estate by paying income taxes nowincome taxes now

If you are confident that you will have high returns on If you are confident that you will have high returns on the investments in the Roth IRAthe investments in the Roth IRA

When are Roth Conversions DisadvantageousWhen are Roth Conversions Disadvantageous

When your tax rate will go downWhen your tax rate will go downin the futurein the future

When you don’t have enough assets outside of When you don’t have enough assets outside of your IRA to pay the taxes on the conversionyour IRA to pay the taxes on the conversion

When you don’t have enough time for the When you don’t have enough time for the compounding to work its magic (i.e. if you need compounding to work its magic (i.e. if you need

the money to live off of)the money to live off of)

Remember that you can do a Roth Conversion Remember that you can do a Roth Conversion anytime in the future (unless they change the tax anytime in the future (unless they change the tax

laws)laws)

Remember that you should integrate a Roth Remember that you should integrate a Roth Conversion strategy with your estate planning Conversion strategy with your estate planning

strategystrategy

Remember that you should make sure your Remember that you should make sure your beneficiary designations forms are completed and beneficiary designations forms are completed and

updated for all of your IRAsupdated for all of your IRAs