Publications
11.18.09
2010 Roth Conversions
If your traditional IRA has dropped in value and you expect to pay higher federal income tax rates in future years, now might be a very good time to consider converting all or part of your traditional IRA balance into a Roth IRA. Here's why. If you convert, it will trigger a current tax hit on the amount you convert. But, with your traditional IRA balance at a depressed level (and possibly your overall income too), the tax hit will be less. After the conversion, your new Roth IRA balance can build up federal-income-tax-free. Eventually you can take tax-free withdrawals after age 59, when your marginal tax rate may be higher (perhaps much higher) than it is right now.
Roth Conversion Basics
A Roth conversion is treated as a taxable distribution from your traditional IRA because you're deemed to receive a taxable payout from your traditional IRA with the money then going into the new Roth account. So, a conversion will generally trigger a current federal income tax bill (and maybe a state income tax bill too). But the following positive factors may outweigh the current tax hit.
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The conversion tax hit is reduced if the value of your traditional IRA has been beaten down by stock market losses.Today's tax rates might be the lowest you'll see for the rest of your life. If so, converting would allow you to completely avoid higher future federal income tax rates on the entire post-conversion increase in the value of your Roth account.
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The Roth conversion privilege is not available to everyone this year. For 2009, it's only available if your modified adjusted gross income (not including any additional income triggered by the conversion itself) will be $100,000 or less.
Good News: For 2010, the $100,000 restriction is scheduled to completely disappear, which will allow all individuals to take advantage of the Roth conversion strategy no matter how high their income. If your income level prevents a 2009 Roth conversion, you can do one in 2010. And 2010 is almost here!
You Can Reverse an Ill-advised Roth Conversion
Another great thing about the Roth conversion strategy is you can always change your mind well after the fact. Believe it or not, you have until October 15 of the year following the conversion year to recharacterize (unwind) your converted account (or accounts). For example, say you convert two traditional lRAs into Roth accounts in early 2010. Later next year, the values of the converted accounts plummet due to poor performance of the investments held in the accounts. In this bleak scenario, you would pay 2010 income tax on value that later disappeared. Bad idea! Thankfully, however, you have until October 15, 2011 to recharacterize the two converted accounts back to traditional IRA status. It's as if the ill-advised conversions never happened. So, you won't owe any 2010 income tax on the now-unwound conversions.
Conclusion
Low current tax cost for converting plus the chance to avoid higher future tax rates on income and gains that will accumulate in your Roth account as the economy recovers (we hope) may add up to the perfect storm for the Roth conversion idea. That said, please contact us before pulling the trigger. There are a number of variables to consider, and we would welcome the opportunity to work with you to ensure a well-informed and thoughtful decision.
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