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2010 - Roth IRA's Profile to Increase Dramatically - Jan 6, 2010

Posted by: Steven P. Schertz in Articles

Amper, Politziner & Mattia wrote the article below about traditional and Roth IRA's. Retirement planning is something that individuals should review annually if not more so. We are not as diligent as our parents who saved for their retirement with a vengeance. Also, we will require more resources and capital in our retirement. Accordingly, effective tax rates on our retirement income may be higher than our parents.

The following article addresses traditional and Roth IRA's.

Next year marks the first year in which taxpayers, at all levels of income, will have the ability to convert funds in Traditional IRAs to Roth IRAs. This ability to convert will be a crucial aspect of retirement and tax planning for 2009, 2010 and 2011.

A conversion from a Traditional IRA to a Roth IRA is subject to Federal and State tax as if it were distributed from the traditional IRA and not re-contributed to another IRA. However, it is not subject to the 10% premature distribution tax.

2010 Change. For tax years beginning after 2009, the $100,000 modified adjusted gross income limit on conversions of traditional IRAs to Roth IRAs has been eliminated. Additionally, married taxpayers filing a separate return will also be able to convert amounts in a traditional IRA into a Roth IRA. This will grant everyone the ability to convert their Traditional IRAs to Roth IRAs.

Why convert?

   1. Distributions from regular IRAs are taxed as ordinary income. By contrast, Roth IRA distributions are tax-free if they are “qualified distributions.”
   2. Roth IRAs are not subject to the lifetime required minimum distribution rules that apply to regular IRAs in the year in which the owner attains the age of 70 1/2.
Unique factor for 2010 conversions. Gross income from the conversions in 2010 will not automatically be includible in taxable income for 2010; rather half will be includible for 2011 and the other half will be includible for 2012. However, a taxpayer may elect to include the full amount of the income from conversion in 2010.

Conversion Strategy is Especially Attractive to:

   1. Those who believe that the future tax free appreciation in a Roth IRA would more than offset the taxes paid on the conversion.
   2. High income earners who are not eligible to fund Roth IRAs. These taxpayers now have the ability to do so indirectly. By making non-deductible contributions to a Traditional IRA and subsequently converting the funds to a Roth IRA, these individuals now have a way to continually fund Roth IRAs.
   3. High net worth individuals who are subject to a wealth transfer tax. By transferring the funds from a Traditional IRA to a Roth IRA, the individual would be removing assets from the estate by prepaying taxes on the income and they will no longer be subject to required minimum distributions beginning at age 70 1/2. In addition, when the beneficiaries receive distributions from the Roth IRAs the income will be received tax free.
Special Added Feature – The Use of Hindsight!

An individual who converts from a Traditional IRA to a Roth IRA can later “back out” of the conversion by electing to re-characterize the IRA as a traditional IRA. If they wish, they can convert after 30 days. This re-characterization/reconversion strategy could be useful where, for example, the investments held in an IRA drop in value precipitously after a conversion to a Roth IRA. Re-characterizing the amount back to an IRA, and then reconverting it to a Roth IRA, can reduce the income arising from the Traditional IRA-to-Roth-IRA conversion.

Care should be taken as the top 2011 tax bracket is scheduled to be 39.6% versus 35% in 2009. An individual can elect to re-characterize up to the filing date of the return, including extensions. This could provide a 21 month window in which to make a decision.

Planning Tip:

Note that an individual can convert a traditional IRA into multiple Roth IRA accounts, each containing different investments. Doing so would allow the individual to “back out” of the conversion only with respect to the Roth IRA accounts containing investments that depreciated in value and not “back out” of the Roth IRA accounts that did not depreciate in value.