You have likely heard and read a lot about Roth IRA Conversions in 2010. The reason is that this year offera a significant opportunity for anyone with funds in a “Traditional” IRA. Traditional IRA’s allow for deductible contributions, but require taxable distributions commencing when the account holder turns 70 ½. Roth IRA’s are not deductible going in, but all distributions are tax free. There are also no required distributions to the original account holder or spouse. Funds remaining for children or grandchildren must be distributed according to the beneficiary’s life expectancy, but are still tax free. Under some circumstances a Traditional IRA can be converted to a Roth. Generally to do so you pay tax on the value of the account at the time of the conversion. Whether this is wise is a function of the numbers involved. Unfortunately projections must be based on unknowns, such as growth rates of the IRA and tax rates at the time of distribution.
For the year 2010, and only for 2010, there are several significant opportunities. First, a “Roth Conversion” may be elected, but the tax can be deferred to 2011 and 2012 – half each year. Secondly, you can change your mind and “unconvert” at any time prior to the filing of your 2010 tax return. This can be up until October 15, 2011 if you file an extension. Finally, the limitation of $100,000 of “Modified Adjusted Gross Income” has been eliminated for conversions for 2010. In other words, everyone is eligible for a Roth conversion, even those who may not be able to otherwise establish one because of the income limitations. Rollover IRA’s containing funds from 401-k’s and similar plans are also eligible.
Most commentators believe that anyone who can afford to pay the conversion tax should strongly consider this. This is particularly true if you believe that income tax rates will go up, and if your long term view of the economy is relatively positive. Furthermore, if you believe that you will not need to take all of the “required” distributions at 70 ½, you are good candidate. The potential for decades of tax-free growth and tax-free distributions for children or grandchildren makes the concept even more attractive in the right situation. If you combine a Roth conversion with the use of an IRA Protection Trust you have a tremendous planning opportunity.
Even if you are not sure, the idea bears exploration. We can help you think about it. It would be a good idea to involve your financial advisor and accountant as well. If you decide to do it, here is a short checklist:
1. Start planning NOW. Don’t wait until the end of the year.
2. Do the conversion early in 2010. This will likely reduce the tax you will pay, and give you the maximum amount of time to evaluate “after the fact”.
3. File an extension for your 2010 return, but be certain all of your taxes are paid timely.
4. Consider what source of funds you will use to pay the tax so as to make the transaction as tax-efficient as possible.
5. Remind yourself to evaluate the transaction in late summer of 2011.
