2010 Provides a unique opportunity for IRA owners.
In 2010, you have the opportunity to convert your traditional IRA to a Roth IRA. The usual income limitations that stand in the way for converting will not apply. So, should you convert? Let’s look at why this may or may not be a good idea.
Here’s why a Roth IRA conversion may make sense for you
Consider this: a Roth IRA allows tax-free growth and tax-free income distributions at age 59½ or older and as long as you have held your Roth account for 5 years or longer. While your contributions to a Roth IRA do not allow a tax-deduction, the younger you are, the longer time frame you have for tax-free growth.
Now realize converting to a Roth IRA comes with a price tag. You will have to pay ordinary income taxes on the amount you convert. Whatever amount is converted is added to your income for the year. However, there may be a silver lining: With the market being down, most likely your account value may be the lowest it has been in years. This means by converting now you may pay lower taxes.
It is also worth noting that with all of the reckless government spending, there is a great chance that tax rates could increase in the years ahead. This is another reason why now may be as good time as ever to convert. If converting may send you into a higher tax bracket, you could consider doing a partial conversion (only converting a portion of your Traditional IRA to avoid going into the next bracket).
Even if you are older, a Roth still may make sense. Normally with an IRA, at age 70 ½ you are required to withdraw from your IRA through mandatory required distributions. However, with a Roth, there is no mandatory withdrawal rule allowing you more time to accumulate tax-free. Also, under the present tax laws, converting a traditional IRA to a Roth can lower the size of your taxable estate. This type of prudent estate planning could allow for decades of tax-free growth for those converted assets.
A few additional estate planning points: If you name your spouse as the beneficiary of your Roth IRA, your spouse can treat the inherited IRA as his or her own after you die and forego withdrawals. This allows those Roth IRA assets to keep compounding untaxed across the rest of your spouse’s lifetime.
Your spouse could then name a son or daughter as a beneficiary. This would allow your children the choice to make minimum withdrawals according to his or her life expectancy. All the while these assets continue growing completely tax-free.
Here’s why you may want to think twice about converting to a Roth
For starters, you will pay taxes now! The IRS treats a conversion from a traditional IRA to a Roth IRA as a taxable event. You will have to pay taxes on the amount you convert. Do you have enough in savings to cover these taxes? If not, you do not, I repeat do not want to pay for the taxes out of your current IRA.
You may be tempted to use your current IRA assets to pay for the tax on the conversion. Here’s why that is not a good choice. First off, if you’re under 59½, you’re facing a 10% penalty on the amount you withdraw, and secondly they amount you take out to cover the taxes will lose the chance for tax-free compounding going forward.
Why wait until 2010?
For some who are under the $100,000 adjusted gross income level, you may consider converting in 2009. Here are a few reasons this may make some sense:
- In 2009, any withdrawals from a traditional IRA can be used to fund a Roth IRA. In years past, mandatory withdrawals from a traditional IRA typically couldn’t be deposited into a Roth IRA. But the federal government has suspended mandatory IRA withdrawals for 2009. Any IRA withdrawals made in 2009 are thereby elective withdrawals. So, if your adjusted gross income (AGI) is $100,000 or less, you have an option to fund a Roth IRA with a withdrawal from a traditional IRA – at least through the end of 2009.
- In 2009, you can fund a Roth IRA with after-tax contributions to a 401(k), 403(b) or 457 retirement savings plan. This year, you can take those contributions and convert them to a Roth IRA tax-free, provided your AGI is $100,000 or less. More good news: there is no limit to the conversion amount.
But don’t ignore the potential tax break for those who convert in 2010
If you do a Roth conversion during 2010, you can choose to divide the taxes on the conversion between your 2011 and 2012 federal returns. This does not apply if you convert in 2009.
Before converting from a traditional IRA to a Roth, be sure to consult your tax advisor. This is a very good idea before you arrange any rollover, trustee-to-trustee transfer, or same-trustee transfer of your IRA assets. In any year, you should fully understand the potential tax impact of a Roth conversion on your finances and your estate. Also, remember that while the income limit on Roth IRA conversions will go away in 2010, the income limits on Roth IRA contributions still apply next year and for the foreseeable future.
Where to go to Convert your IRA to a Roth
| Name | Acct Min | Inactivity Fees? | Trading Fees | Other Notes |
| Zecco.com |
$25,000 | No | Free | You get 25 free trades each month if you meet the minimum balance requirement |
| $0 | No | $4.95 | ||
| Sharebuilder |
$0 | No | $4.00 | Currently offering $100 bonus if you transfer your acct from another broker. |
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What about Rollover IRAs? I know they’re technically different than the Traditional IRA but do the same rules mentioned in your post apply to the Rollover IRAs?
Very timely post. Hubby and I are considering coverting our traditional IRAs next year. I will probably run our taxes both ways to determine what the additional tax burden would be and go from there.
@ Darrin
Rollover IRA’s would qualify, too. Any type of old retirement plans will qualify as well.
Keep in mind that taxes only have to be paid on deductible contributions as well as investment earnings, so the entire amount of your conversion is not always taxable.
As a result, in 2010, you can fully fund a Traditional IRA with non-deductible contributions, and immediately convert to a Roth IRA without tax consequence.
Because of this “loophole,” the Roth IRA income limits effectively disappear as well.
If I transferred a Roth IRA from one brokerage firm to a different brokerage firm, then does the “have held your Roth account for 5 years or longer” rule apply to the total combined time with both brokerage firms? Or, does the 5 years have to be with the same firm?
@Britt
That is only true if all you have are non-deductable IRAs. If any of your IRAs (if you have multiple) have deductable money(i.e. a rollover IRA) all of your IRAs are treated as such.
Here’s my take (a comment I left elsewhere on this exact issue):
If one retired today, no pension, no other income, it would take over $2M to fill the 15% bracket. As inflation impacts the tax brackets themselves, along with the standard deduction and exemption amounts, it’s not fair to say that since one sees $3M in their account in 30 years that puts them in a higher bracket. Looking forward you’d have to adjust for inflation. If people who are now in the 15% bracket wish to save in a Roth or convert to ‘top off’ that 15% bracket, I have little objection, but those the ‘10 law applies to (earning $100K) are the very people who shouldn’t be using Roth in the first place.
I see a lot of talk about ‘rates going up’ but very little discussion on just what it takes to reproduce the kind of income it would take to simply be at the same level. I suspect few will manage to be in the same bracket at retirement, let alone exceed it regardless of general increases in the tax structure.