Blog | WM. F. Horne & Company, PLLC


New Roth IRA Opportunities

2010 is the first year in which taxpayers—including married taxpayers filing separately—are able to convert funds in regular IRAs (including SEP and Simple IRAs) to Roth IRAs, regardless of income level. This can provide a significant opportunity for certain taxpayers.

There are several advantages to a Roth IRA – All future earnings and distributions at retirement generally will be tax-free, and Roth IRAs are not subject to the required minimum distribution rules. Because distributions from Roth IRAs are tax-free (if they are qualified distributions), they may keep a taxpayer from being taxed in a higher tax bracket than would otherwise apply if he were withdrawing taxable distributions. Roth IRAs don’t enter into the calculation of tax owed on Social Security payments and have no effect on AGI-based deductions. What’s more, the benefits flow through to beneficiaries of inherited Roth IRA accounts, who also can make tax-free withdrawals from such accounts (beneficiaries, however, are subject to the same annual post-death minimum distribution rules that apply to beneficiaries of regular IRAs).

Conversion downside – The conversions are taxable, except for previously non-deductible amounts, but they are not subject to the 10% premature distribution tax.

Should you make an IRA-to-Roth IRA conversion? Generally, taxpayers with the following tax profiles should consider making a conversion:

  • Those who still have a number of years to go before retirement and time to recoup conversion tax dollars.
  • Those in a lower-than-normal tax bracket in the year of conversion.
  • Those who anticipate being taxed in a higher bracket in the future.
  • Those who can pay the tax on the conversion from funds other than non-taxed retirement funds.

Complicating factor for 2010 conversions – A unique income inclusion rule will apply for IRA-to-Roth-IRA conversions occurring in 2010. Unless a taxpayer elects otherwise, none of the gross income from the conversion is included in income in 2010; half of the income resulting from the conversion will be includible in gross income in 2011 and the other half in 2012. This requires some careful planning since it is anticipated that taxes will rise in future years.

Additional items to take into consideration:

  • It might be appropriate for you to design your own custom conversion plan over a number of years rather than convert everything at once.
  • Where does the money to pay the conversion tax come from? Generally, it must be from separate funds. If it is taken from the IRA being converted, then for individuals under age 59½, the funds withdrawn to pay the tax will also be subject to the 10% early distribution penalty in addition to being taxed.
  • Unlike conversions, annual contributions to Roth IRAs are not allowed for certain higher-income taxpayers. However, that problem could be circumvented by contributing to a non-deductible traditional IRA and then making a conversion to a Roth IRA in a subsequent year.
  • If the traditional IRA being converted consists of assets such as stocks and mutual funds that could decline in value after the conversion, it may be appropriate to apply for an automatic six-month extension to file the conversion year’s return. By waiting to file until the extended due date (October 15 for most individuals), the taxpayer has an opportunity to compare the account’s market value at that time to what it was when the conversion was made. If the value has dropped significantly, the taxpayer may elect to undo the conversion (called a “recharacterization”), provided certain requirements are met, and avoid paying tax on the higher value. After a specified waiting period, a reconversion can be made.

Conversions can be tricky! If you are considering a conversion, please call for an appointment so this office can help you properly analyze your conversion and contribution options.

  • 11 Nov, 2010
  • webmaster

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