Expanded Roth IRA conversion opportunity in 2010

BY KAREN MATLAND, CPA, CTFA

Effective for tax year 2010, there is an expanded opportunity to convert traditional IRA or certain other retirement plan assets to Roth IRA assets as provided for in the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005.

While this opportunity may not be appropriate for everyone, some taxpayers should review the changes and have a discussion with their Tax Advisor to assess the effects of converting all or some of their IRA assets.

Traditional IRAs have been in existence since the mid-1970s and have provided taxpayers with a vehicle to set aside retirement funds in a tax-deferred account. Contributions to them could be either deductible or non-deductible, and distributions could be partially or fully taxable. Roth IRAs were introduced in 1998, and although their contributions were never deductible, their qualified distributions including tax deferred earnings were never taxable.

Traditional IRA owners are required to take annual distributions after they reach age 70½, Roth IRA owners are not. Although both Traditional and Roth IRAs are considered taxable estate assets, distributions to Roth IRA beneficial owners are generally tax free.

Prior to tax year 2010, taxpayers with “modified” adjusted gross income equal to and exceeding $100,000 were not eligible to convert traditional IRA assets to Roth IRA assets. Effective for tax year 2010 and subsequent years, the “modified” adjusted gross income limitation has been removed. Essentially, every taxpayer is eligible to convert IRA assets. Further, the federal tax due on the conversion can be deferred over a two-year period, payable ratably in tax years 2011 and 2012. It should be noted that the conversion will likely have state income tax implications; the discussion of which is beyond the scope of this article.

If you find that the following circumstances are applicable to you, then a further discussion with your tax adviser is recommended. Generally, it makes sense to consider converting IRA assets during tax year 2010 if you expect to have:

• Unusually low taxable income and/or tax rate for tax year 2010 – If you expect reduced income or increased deductions/losses, it may be tax cost effective to convert IRA assets.
• Higher income and/or tax rate during retirement years – If you expect during your retirement years an increased amount of taxable income and an increased marginal tax rate, then converting taxable IRA assets now while the tax rates are lower may be cost effective.
• A long timeframe between conversion and retirement date – Since in nearly all cases there is a tax cost to converting, the longer the time between conversion and distribution, the more time for tax deferred growth.
• Available liquid assets in non-tax deferred accounts to pay the tax on conversion – Without question, it is always best to pay the tax due on the conversion with non-tax deferred funds. Since the amount of tax due could be significant, it is important to plan ahead.
• No need to use converted assets for at least 5 years – If you need to use any of the funds in your converted Roth IRA account within 5 years of the 2010 conversion and you are under 59½, you should be aware that there could be income tax and a 10 percent penalty due on the distribution. Ideally, it would be best to convert only the amount of IRA assets that will not be needed at anytime during your lifetime.
• A taxable estate – For those taxpayers with an expected taxable estate, the likely cost to convert will reduce estate assets in the short run, but also provide beneficiaries with an income tax-free Roth IRA account inheritance.
• IRA beneficiaries in a higher tax bracket – Since it is always advisable to consider the affect of different strategies with a multi-generational focus, it may make financial sense to convert in 2010 and take advantage of the deferred payment options particularly if the ultimate recipients of the IRA will be next generation beneficiaries who will be in a higher tax bracket than the original IRA owner.

While the ability to convert traditional IRA assets to Roth IRA assets for eligible taxpayers has been available since 1998, the changes effective for tax year 2010 have expanded the eligibility criteria, and offer the ability to pay the tax due on the conversion over a multi-year period.

There are many factors to consider before making a decision to convert some or all of your traditional IRA. For starters, take a look at the Roth IRA Conversion Calculator at capecodfive. com. Then, consult a professional about whether a Roth IRA conversion makes sense based upon your unique set of circumstances. ■

Karen Matland, CPA, CTFA, is Director of Financial Advisory and Retirement Services at The Cape Cod Five Cents Savings Bank. She can be reached at kmatland@capecodfive.com or (508) 247-2327.


Published in Cape & Plymouth Business March 2010