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For 2010
ONLY, taxpayers can convert their traditional IRA's to a Roth IRA
without penalty and choose to postpone taxation of the conversion until
years 2011 and 2012. Also, for the first time ever, there is no income
limitation for IRA to Roth rollovers. Prior to 2010, only taxpayers with
modified adjusted gross income of $100,000 or less were able to convert
to a Roth.
Roth IRA
conversions are now available to ALL taxpayers. An added benefit of
converting in 2010 is the extra time to pay the tax. Upon conversion,
half of the income can be reported on the 2011 tax return and the rest
on the 2012 return. Taxpayers in higher income tax brackets may wish to
elect to pay the tax in 2010 rather than in 2011 and 2012 as tax rates
are likely to increase beginning in 2011. You also can make the
conversion and then change your mind and undo the conversion anytime up
to the 2010 filing date for your tax return, including extensions of
time to file. Therefore, you could wait until as late as October 15,
2011 (if you file an extension) to make the final decision!
Roth IRAs
are different from traditional IRAs because they are more liquid. You
can withdraw funds more easily out of a Roth before retirement age
without penalty, after you have had the Roth for more than 5 years.
Also, earnings on a Roth may never be taxed at all if you do not
withdraw the earnings portion until after age 59 ½. With Roth IRA's,
there are no minimum distribution rules, so you are not required to
withdraw funds at age 70 ½.
Another major difference is that Roth IRA's are funded with after-tax
money. You get no deduction for contributions to a Roth. So when you
convert a traditional IRA, which has never been taxed, into a Roth IRA,
you must pay the income tax on the portion of the account that was
funded with pre-tax dollars.
Strategies
You must consider where you will get the money to pay the extra tax if
you decide to rollover your IRA into a Roth. Also, you should elect the
two-year income split if a one-year rollover would push you into a
higher tax bracket. If you already are in a high bracket, you may want
to take the entire rollover amount into income in 2010 since it is
possible that tax rates may increase for higher income individuals in
2011 when the Bush tax cuts expire. If you expect to be in a lower tax
bracket in 2010 because of a job loss or other reduction in income, you
may want to take all of the rollover into income in 2010. Again, you
must have a source of funds to pay the income taxes. Finally, if you
have other losses, such as net operating losses from a business, it may
be time to make the switch to a Roth. These losses can help offset the
increased income from a Roth conversion.
Special Rule for Inherited IRA's
If a taxpayer inherits an IRA from his or her spouse, the taxpayer can
elect to treat it as the taxpayer’s own plan and can roll it over into a
Roth IRA. If a taxpayer inherits an IRA from anyone besides a spouse, it
may NOT be rolled over into an inherited Roth IRA. |
