This article discusses the Roth IRA Conversion 2010 Rules. Anyone with a Traditional IRA or a 401K from an old job might want to get the information below. It could potentially save you more money in taxes during retirement than you’d pay now to make the move. It’s a lot of tax information for me to cover so if you find something that’s amiss or confusing just make a note in the comments below.
Roth IRA Conversion and the New Rules for 2010
I’ve never really discussed the Roth IRA conversion on the blog before, but now I have a good excuse. In 2010 (pronounced “twenty-ten” for all you insistent on holding onto the “two-thousand”) the TIPRA is going into effect and the IRS is permanently removing the income restrictions on who is allowed to convert a traditional IRA to a Roth IRA.
They are also allowing those who convert to a Roth IRA in 2010 to either take in hit in income in 2010 OR spread the income out to 2011 and 2012 (50/50). In short, you could end up paying less in taxes by using this strategy, which might have been unavailable to you before.
What is a Roth IRA?
Let’s quickly recap what a Roth IRA is for those that might want to move into one for the first time. Then we will dig into the new conversion rules.
Like a Traditional IRA, a Roth IRA allows you to contribute savings to retirement with certain tax advantages. This is up to $5,000 or 100% of your pay, which ever is less, annually. The IRS permits additional catch-up contributions of $1,000 if you are 50 or older. See more info on the Roth IRA contribution limits.
Unlike a Traditional IRA, the Roth IRA has limitations on the amount of income you can make to be able to make contributions. In 2009, the phaseout limit began at $105,000 for single filers.
Also, the Roth IRA can only accept after-tax contributions (for example, money that you get in your check after your employer pulls out your taxes). The Roth allows you to withdraw earnings tax-free, if it’s been five years since you started contributing AND you meet the IRS requirements (reached age 59 1/2). With a Roth IRA you can withdraw contributions at anytime, tax free. At no time are you required to withdraw funds.
Because of the different tax treatment of the Roth IRA, and the fact that it hasn’t been around as long as the Traditional IRA, you can quickly see why some people might want to move their money from one to the other. This process is called a conversion.
Special Conversion Rules for 2010
I’ve split up the next section into 3 periods: pre 2010, 2010, and post 2010. This will be a good way to illustrate how the conversion rules are changing.
Prior to this year, individuals earning more than $100,000 could not convert their Traditional IRA funds to a Roth IRA. This was a little disappointing for some people since they’d spent years contributing to a Traditional IRA before the Roth was available. And when it finally was available, they were restricted from using it.
If you could convert to a Roth IRA in 2009 or before, the amount you converted was taxable when converted (in the same tax year).
In the Year 2010
Thanks to TIPRA, things are changing for 2010. There has been a permanent repeal of the $100,000 income limit on conversions. Anyone can convert, regardless of income.
Also, this year only, the IRS will allow you to split taxable income between 2011 and 2012 (either,or).
Going forward, after 2010, individuals of all income levels can make Roth IRA conversions. And conversions must be reported as taxable income in the same year they were made (so the 50/50 rule goes away).
Common Questions About the Roth IRA Conversion
Do the income limits for Roth IRA contributions still apply?
Yes. Only the income limits for conversions were removed.
Can you convert a 401K to a Roth IRA?
No. But you could possible roll over a 401k to a Traditional (rollover) IRA, depending on certain rules (no longer with the company, no tax effect, etc.), and then convert the Traditional IRA to a Roth.
Will you have to pay interest to the IRS if you chose to do the 2011 and 2012 recognition on the conversion income?
No. There is no interest you need to pay for delayed income recognition.
Will you need to sell your investments in the Traditional IRA and buy new investments in the Roth IRA?
No. You don’t have to sell assets as long as you are using the same company and they carry both account types, which is very common.
Does the money to pay the taxes have to come from an outside source?
Yes. The money you use to pay taxes on the conversion must come from a new source and not the Traditional IRA.
Key Considerations When Deciding to Convert from a Traditional IRA to a Roth IRA
Who Should Convert?
To help you apply all of this to you and your situation, let’s look at some factors. You should strongly consider converting if you…
- Want more control over future withdrawals
- Think you’ll be in a higher tax bracket in the future
- Won’t need to tap into Roth IRA converted amounts within five years
- Want your beneficiaries to inherit your account tax free
You May Not Want to Convert If
It might not be in your best interest to convert if you…
- Expect to be in a lower tax bracket in the future
- Need to tap into converted amounts within five years
- Think the taxable conversion income may bump you into a higher bracket
- Won’t readily be able to pay taxes on the amount you convert
So there you have it. Plenty of information to absorb regarding the 2010 conversion changes. I’m sure some will have questions. Fire away and I’ll try my best to track down an answer.
p.s. I’ll likely pass on doing a conversion in 2010. I actually like having some of my money in a 401K and Traditional IRA, and some in my Roth IRA. It keeps me in a more diversified tax position for retirement, I think.
Photo by D?de?ek