Benefit Strategies
The New Roth IRA Game Changer
Roth IRA conversions are about to become a big deal for those saving and investing for retirement. Under the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), all taxpayers will be able to convert all or some of their traditional IRAs into a Roth IRA, regardless of income. Read the following highlights of the biggest game-changer since the introduction of Roth IRAs.* Under TIPRA you don’t have to report the “amount converted” on your 2010 tax return. Instead the Roth conversion done in 2010 will be reported on your 2011 and 2012 tax returns. Thus, if you convert a $100,000 IRA in 2010 to a Roth IRA, you would report $50,000 in ordinary income in 2011 and $50,000 in 2012. For conversions in 2011 and beyond, you don’t get to spread the income tax bill over two years.
*If you split the income, you have to pay the taxes on your 2011 and 2012 tax returns. If you think splitting the income will create a larger overall tax bill, you can opt out of splitting the income and pay all taxes in 2011.
* With a Roth IRA you get to withdraw your investment income tax free once you have owned your account for five years and have reached age 59 1/2 . But when you do a Roth IRA conversion, there’s a separate five-year clock that applies tp “conversion basis amounts”. If you are under age 59 1/2 at the time of a Roth IRA conversion, the amount you convert is subject to taxes, but not the 10% early withdrawal penalty that typically applies to taxable distributions taken prior to age 59 1/2. However, the government does not want you to use the IRA conversion option as a work-around for avoiding the 10%early withdrawal penalty. So, to avoid this potential abuse, conversion basis removed from a Roth IRA within five years of conversion is potentially subject to a recuperative 10% penalty assuming you are still under 59 1/2 at the time of Roth distribution.
*Participants of SEP IRAs and even SIMPLE IRAs can convert to the Roth IRA provide that that the early distribution penalty from their SIMPLE IRA would not apply. Participants in 401(k)s, 403(b)s and 457 plans can also avail themselves of Roth conversions, provided the funds are eligible for in-service distributions.
*You can do a partial conversion; you can also convert nondeductible traditional IRAs.
*If you do not have sufficient funds to pay taxes from sources outside your IRA, you should probably not pursue the Roth conversion. One reason for not using IRA funds for taxes is that in the event of a recharacterization of your Roth account back into a traditional IRA, you would not be able to replace the funds taken from the IRA to pay taxes.
If you have any questions about or would like to explore your Roth IRA conversion opportunities for 2010 , please give Donald Potter a call at (540) 989-2020. We can provide you with a detailed analysis of which IRAs should be converted, what your tax costs would be and project the advantages and disadvantages of your Roth conversion opportunities over time. Find out how a Roth conversion in 2010 could be a game-changer for your retirement plans.