| 7 Things You
Should Know Regarding Roth IRA Conversions in 2010
(December 5th, 2009)
A Roth IRA (Individual Retirement Account) conversion
allows investors to convert their retirement funds from a traditional
IRA or 401k to a Roth IRA. A Roth IRA conversion also permits the
flexibility of converting a portion of the traditional IRA or the
entire IRA, depending on the preference of the investor. Starting
2010, anyone who has a traditional IRA will be able to convert it
to a Roth IRA without undergoing the pain of passing the modified
adjusted gross income limit test, which is set at $100,000 or less.
Thus prior to 2010, if an investor with a traditional IRA makes
$100,000 or more, he is NOT eligible to convert it to a Roth IRA.
Also in 2010, a Roth conversion that was previously reported as
income for the year it was converted will be split in to half and
reported in the years 2011 and 2012, thus not reported as income
for the year 2010. This allows the investor to defer paying taxes
on his conversion for 2 years, which is a great feature of the new
rules for Roth IRA conversions.
Which Types of Accounts Can be Converted to a
Roth IRA?
During current years, you can convert a Traditional
IRA and other employer-sponsored qualified retirement plans such
as a traditional 401k, SEP 401k, etc to a Roth IRA. For any inherited
assets, you can only convert those assets to a Roth IRA if you inherited
them from your spouse. The best way to deal with this is to check
with your 401k plan administrator or advisor.
7 Things You Should Know About Roth IRA Conversions
i) Adjusted Gross Income Level is $100,000
Starting 2010 whether you file as a single or
married filing joint, the current adjusted gross income rule of
$100,000 will be phased out. This creates opportunity for highly
compensated employeees who previously could not contribute to a
Roth IRA due to their higher salaries with a maximum cap of $100,000.
ii) You Can Convert Now
For non highly compensated employees who makes
$100,000 or less every year, now is the time to make a Roth IRA
conversion! Since 2008 was a year when the stock markets such as
the Dow Jones Industrial Average took a hit of -33.8%, this is a
good time to make a Roth IRA conversion since your account values
will be lower, thus your total tax payable on the conversion will
be lower as opposed to if you do it when the market appreciates
again.
iii) Income Deferral in 2011 and 2012
When you make the Roth IRA conversion in 2010,
the income to be included in your income tax will be split between
the years 2011 and 2012. Since millions of Americans will be taking
advantage of this, the IRS has set up a rule of how this will be
worked. The IRS grants you the option of claiming 50% of the income
in 2011 and 50% of it in 2012. Note that this is only the case if
you make the Roth conversion in 2010, if you convert in 2011, you
will have to include 100% of your income in your tax year 2011.
iv) Save for Taxes Now
Since you will have to pay taxes for a Roth conversion
done in 2010, you have almost 1 and 1/2 years to add some extra
money to your emergency fund each month to be able to pay the tax
bill later.
v) Contribute to a Non-Deductible IRA?
Just because the $100,000 adjusted gross income
limit for conversions to a Roth IRA is lifted does not mean the
income phase out ranges for Roth IRAs are phased out as well. There
are still limits on how much you can contribute to a Roth IRA. To
avoid these limits, you could contribute to a non-deductible IRA
and then immediately convert to a Roth IRA and avoid paying taxes.
vi) Unlimited Conversion Options
The 2010 conversion option is not limited to
just traditional IRA conversions to Roth IRAs. You could also convert
traditional 401k plans from past employers, or other types of qualified
retirement plans.
vii) What is the Cost Basis?
If you had an old qualified 401k plan that
you rolled to a Traditional IRA and would now like to convert that
Traditional IRA to a Roth IRA, what amount would you use? For instance,
say you had $50,000 in your old 401k plan that you converted to
the traditional IRA. Your traditional IRA is now worth only $30,000,
so what will the cost basis be when you convert to a Roth IRA? The
tax cost basis will be $30,000!
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