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Articles: Tax decision on Roth IRA conversions

April 18, 2011, is a red-letter day for some retirement- savers. It’s the tax return deadline for deciding whether or not to “split” a Roth IRA conversion that occurred in 2010. (The usual April 15th due date has been extended due to the Emancipation Day holiday in Washington, D.C., and the subsequent weekend.) The decision should reflect several key factors.

Background: Contributions to a traditional IRA may be wholly or partially tax-deductible, depending on income limits and whether you (or your spouse, if you are married) actively participate in an employer sponsored retirement plan. When you receive distributions from a traditional IRA, the amount representing deductible contributions and earnings is taxed at ordinary income rates.

In contrast, Roth IRA contributions are never tax- deductible, but “qualified distributions” (e.g., distributions received after age 59½) from a Roth in existence at least five years are completely tax-free. Furthermore, unlike a traditional IRA, you don’t have to take required minimum distributions (RMDs) after age 70½.  If you convert a traditional IRA to a Roth, the taxable portion of the converted funds is taxed at ordinary income rates, just like a traditional IRA distribution.

Prior to 2010, you could not convert a traditional IRA to a Roth in a year in which your modified adjusted gross income (MAGI) exceeded $100,000. This restriction was lifted in 2010. Also, for a conversion occurring in the 2010 tax year—and 2010 only—you can choose to divide the taxable income from the conversion evenly over the following two years. In other words, you can split the tax bill on a 2010 conversion between your 2011 and 2012 tax returns.

Hypothetical example: John Jones is normally in the
28% tax bracket, but a $100,000 conversion in 2010 would result in a portion of his income being taxed at the 33% rate. John may decide to have the taxable income split evenly between 2011 and 2012 if he expects all of the income to be taxed at the 28% rate for those two years. Thus, he saves tax overall while deferring payment.

Be careful, however, if you expect to be in a higher tax bracket after 2010, due to certain events or changes in your personal circumstances.   For example, if you expect to generate a huge capital gain in 2011 from the sale of securities, you might opt to pay the entire tax due from the conversion on your 2010 return if your tax rate for 2010 will be lower than your projected 2011 rate. Other complications may arise due to potential alternative minimum tax (AMT) liability.

Coordinate activities with the assistance of your financial and tax advisers. They can help you determine the best approach for your situation.

This newsletter/advertisement is produced for our clients, friends and associates through an arrangement with WPI Communications, Inc. for the representatives’ use. Although the editorial content is professionally researched, written and edited, neither our firm nor any of its agents, representatives or associates make any representations regarding the accuracy of the content or its applicability to your situation. The information in this communication is not intended as tax or legal advice. In accordance with IRS Circular 230, the information provided herein may not be relied on for purposes of avoiding any federal tax penalties. Any tax advice contained in the body of this material was not intended or written to be used, and cannot be used, by the recipient for the purpose of 1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or 2) promoting, marketing or recommending to another party any transaction or matter addressed herein. You are encouraged to seek tax or legal advice from an independent advisor.


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