Effective this year, converting from one’s traditional IRA (or other qualified plans such as 401k, 403b and 457) to a Roth IRA is available to everyone. There are benefits and burdens of conversion, and the purpose of this article is to provide you with several things you should consider when converting to a Roth IRA.
When you convert your traditional IRA to a Roth IRA, the cost of conversion is the “conversion tax,” which is calculated by multiplying the value of the IRA on the conversion date, less your basis in the account, by your marginal ordinary income tax rate.
Conversion in 2010 – If ordinary income tax rates increase in the years to come, as many expect, converting in 2010 would result in less overall conversion tax. Also, there is a special rule that says if you convert in 2010, you can either (1) recognize the conversion income in 2010; or (2) defer the income equally over 2011 and 2012. Deferral may be beneficial; however, in an increasing tax rate environment, depending upon your circumstances, you may be paying more conversion tax if you defer.
It’s not an all-or-nothing proposition – There is no requirement that you convert the entire amount of your traditional IRA (and qualified plans) to a Roth IRA. Thus, you can convert any part of your IRA or all, if you believe this is to be a good decision. Also, conversions are not limited to 2010, and so you may want to convert some this year and some in the future year, keeping in mind that the risk that the law permitting conversions could change.
You can “undo” your decision to convert – The new laws have a special provision that allows you to undo your decision to convert. If you do so by the last day permissible for filing your tax return, you don’t have to have any reason for undoing the conversion. The technical term for this is recharacterization.
Consider using multiple accounts to convert – If you have a significant amount that you want to convert, consider using multiple accounts. If one account goes down and the others go up, you may wish to recharacterize, or undo the conversion to the decreased account and later, reconvert that lower-valued account when it is permissible. This strategy may save income taxes.
Conversion is as much an estate tax planning issue as an income tax planning issue. For those who may be subject to estate tax (realizing that at the time of this writing, there is no estate tax this year, but there will be one next year), you must understand the impact of conversion on your total estate plan. There may be provisions in your will or trust that can significantly impact the potential benefit of conversion.
Steven W Tarta has been providing Estate Planning and Elder Law services for over 25 years. His focus has been on “Asset Preservation” resulting in the elimination or reduction of Federal Estate Taxation by the use of Revocable and Irrevocable Trusts. Also, Steven is very concerned with quality of life issues as they relate to his Elder Law practice. Steven provides a conservative and professional approach which analyzes the client’s objectives and creates an appropriate strategy for Asset Preservation as well as addressing all Elder Law issues. Mr. Tarta is also a member of the LawGuru Attorney Network.