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Jim Lentini: New rules for converting IRAs to Roth IRAs

Posted: February 1, 2010 10:14 p.m.
Updated: February 2, 2010 4:55 a.m.
 
One of the important changes happening in 2010 in pension planning is the ability for higher-income individuals to convert traditional IRAs into Roth IRAs.

What’s important about this option?

It gives the IRA owner the ability to have tax-free income at withdrawal time instead of the traditional IRA being taxed as ordinary income under our current tax structure.

A few articles have been written about this option, but it’s worth repeating if the rules and requirements necessary can fit your retirement plans.

Starting in 2010, more than 20 million investors will, for the first time, be able to convert a traditional IRA to a Roth IRA. And all investors who convert in 2010 can delay payment of any federal taxes due on the conversion for a year, and then spread the payments equally over the next two years.

It is important to discuss your options and position with your tax and financial advisors and answer the following questions to be sure a conversion with the rules and taxes now are viable for your situation and plans.

1. What is changing? Prior to 2010, if your modified adjusted gross was more than $100,000, tax rules prevented you from converting your traditional IRA to a Roth IRA. Effective Jan. 1, 2010, there is no earnings limit.

2. Should you convert your traditional IRA? Although converting a traditional IRA to a Roth IRA may not be right for all investors, it may be worth considering if you:

* Can leave the money in the account for five years or more, and at least until you reach age 59 1/2.

* Expect tax rates to rise in the future and, as a result, you would rather pay taxes now.

* Can pay the resulting income taxes from a source other than the IRA so that the full amount of the traditional IRA goes into the Roth IRA to have the opportunity to grow until withdrawal.

3. Will you have to pay taxes? Yes. If you convert, you will likely have to pay income tax on some or all of the conversion amount, as contributions and growth in the traditional IRA that have not yet been taxed.

If you have more than one traditional IRA you will have to factor all of them (including employer-sponsored SEP and Simple IRAs) in the calculations to determine how much of the conversion amount will be taxable — even if you are not converting all of your traditional IRAs.

To ease the tax pain, Congress has approved a special rule for conversions that are completed in 2010 only as noted above.

You can pay half the taxes when you file your 2011 tax return and the other half when you file your 2012 tax return. Conversion rules and tax calculations can be complicated, and state rules for conversion may differ from federal rules.

These factors are why consulting with your tax consultant and financial advisor are so important to see if this option can be of value to you.

Jim Lentini, CLU, ChFC, IAR is president of Lentini Insurance & Investments, Inc. His column reflects his own views and not necessarily those of The Signal.

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