2010 Roth IRA Conversion Opportunities

Determining if a Roth Conversion is Right for You

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In 2010, taxpayers will have the opportunity to convert a traditional IRA to a Roth IRA for the first time.  The benefits of a Roth conversion, as well as the most significant factors to be considered when evaluating the attractiveness of a Roth conversion, are detailed below.

A Roth IRA (Individual Retirement Account) is similar to a traditional IRA, except that contributions are non-tax deductible; distributions are tax free; and there are no required minimum distributions at age 70½ . Due to these features, the Roth IRA can be an attractive option to many taxpayers. 

Changes in the Tax Law

Prior to 2010, a taxpayer can convert their traditional IRA to a Roth IRA if their adjusted gross income is under $100,000. The significance of the year 2010 law change is that during 2010 (and subsequent tax years) the adjusted gross income limitation is removed and all taxpayers have the ability to convert their traditional IRA to a Roth IRA.

Given that a tax-deferred asset is being converted to a tax-free asset, the amount converted to a Roth IRA will be included as ordinary income for the year and will produce a tax liability. Another significant benefit of the 2010 tax law change is that a taxpayer may elect to defer the tax due on the conversion until the 2011 and 2012 tax years. However, a taxpayer does have the option to elect out of the deferral and pay the tax in 2010. This is recommended for those individuals who expect to be subject to higher tax rates in the 2011 and 2012 tax years.

It is important to know that the conversion can be reversed, as long as the reversal is completed before filing the 2010 tax return. The benefit of the ability to recharacterize the conversion back to a traditional IRA is that the investor can react to the changing financial market conditions. If a converted Roth IRA is losing value, the taxpayer can recharacterize, and be refunded, the tax paid on the conversion.

Factors to Consider

The Roth IRA conversion is not the right option for every taxpayer, and there are many factors to consider when making this decision. It is important for a taxpayer to determine their current situation as well as to project expectations for the future. A Roth IRA conversion can be beneficial if a taxpayer anticipates increased tax rates in the future, either based on changes in tax laws or changes in personal income levels. The Roth IRA conversion could also be beneficial if a taxpayer anticipates no need for retirement account distributions in the future. Because a Roth IRA is not subject to the minimum required distribution (MRD) rules at age 70 ½, the value can continue to grow uninterrupted.

The avoidance of MRDs is one of the key benefits available to those who do not expect to need the funds in their IRA to meet their living needs in retirement. By holding the funds in a Roth IRA, and enjoying tax free growth throughout their lifetime, the investor and his or her heirs can recognize significant estate and wealth transfer benefits.

The taxpayer should closely examine his or her current tax situation before executing a Roth conversion in order to weigh the benefit of the conversion against the tax liability the conversion creates. Many taxpayers have "basis" in their IRA accounts as a result of many years of nondeductible IRA contributions. Upon conversion to a Roth IRA, this basis is not subject to tax, and the future growth of the investment will be tax free, rather than tax deferred. Therefore, individuals who have a relatively high basis in their IRA should strongly consider a conversion to a Roth IRA.

A Roth conversion might also be warranted if the taxpayer has a net operating loss, or charitable contribution carryovers available to offset the ordinary income from the conversion.

SC&H Financial Advisors generally recommends that a taxpayer use other assets to pay the tax on the conversion rather than using funds from the IRA to pay the tax. This is an important factor to consider because if a taxpayer needs to use part of the retirement account to pay the tax, he might incur a penalty, as well as deplete the asset.

If cash flow for the tax liability is a concern, one solution could be a partial conversion. Any portion of an IRA can be converted to a Roth IRA; therefore, the amount of the conversion could be determined by the amount of available funds to pay the tax liability.

The decision to convert requires a complicated analysis that should be the subject of careful planning and discussion. Now is the appropriate time to meet with an Advisor and determine if a Roth conversion is possible, and whether it is the right choice for your individual situation.

We encourage you to contact your SC&H advisor or attend one of our Roth conversion seminars in order to learn more.

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Roth IRA Conversion Seminars

There are many considerations around whether making the conversion is advantageous, so please join us to gain some clarity on this exciting, yet complicated, opportunity.

If you want to learn more about the Roth IRA Conversions, contact us or call (410) 403-1512 | (800) 832-3008.