As year-end approaches, it is a perfect time to consider converting a traditional IRA to a Roth IRA. The advantage of being able to take tax-free withdrawals from a Roth IRA makes a conversion attractive. Nevertheless, the decision to convert to a Roth IRA is based on individual circumstances and depends on a number of factors, including the income tax rates today versus future years, how you will pay for the taxes on the conversion, your estate planning, and the size of your traditional IRA.
Planning Tip:
Is there a benefit in the recent downturn in the stock market and the resulting decrease in the value of your IRA? Probably not, but it increases the attractiveness of converting the depressed value in your traditional IRA to a Roth IRA. As the market rebounds over the next several years, wouldn’t it be fantastic to know that the appreciation in the value of your IRA will be forever tax-free?
For 2008 and 2009, there is an income limit on who qualifies to convert traditional IRAs to Roth IRAs. If your modified adjusted gross income, excluding the amount being converted, is less than $100,000, you will be eligible to convert. If eligible, you can decide to convert some or all of your traditional IRAs. Upon conversion, any previously untaxed money in the amount converted will be taxed to you at ordinary income tax rates. The conversion must be completed by December 31.
Suppose you convert now and later find out your income exceeds the $100,000 threshold. The IRS will allow you to return your money to a traditional IRA (also known as re-characterizing the conversion) without penalty, prior to April 15 of the following year.
Should your income exceed $100,000, there is a brief period of opportunity to convert. In 2010, and only 2010, the income limitation will be removed and everyone will be allowed to convert a traditional IRA to a Roth IRA. Additionally, the income recognized on 2010 conversions can be spread over the next two years—included as taxable income in 2011 and 2012—thus helping to distribute the tax bite
Removing the Roth IRA conversion cap doesn't mean anyone can make annual Roth IRA contributions (income thresholds still apply to this), but it does mean that anyone can convert an existing IRA to a Roth IRA.
There are many factors to consider regarding conversion to a Roth IRA, and we have just touched on the highlights. Contact us to arrange an appointment with one of our tax specialists. We’ll assist you in making an informed decision.