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Remember when 2010 seemed like light years away? 2010 is here! We’re one month into 2010 and pretty soon will be seeing the ball drop again. 2010 brings a lot of uncertainty within the financial realm with estate planning and sunset provisions in question.
One thing that is certain pertains to the Roth IRA. The 2010 Roth IRA conversion is just here. Many still are left confused about the rules and not completely certain of what the conversion really means to them. Whether you are looking to convert Traditional IRA’s or 401k’s, here is a look at seven things that you need to know about the 2010 Roth IRA conversion rules.
Reminder: Deadline for converting 401k’s and Traditional IRA’s is December 31st!
If this article was helpful, you may also want to check out these posts as well: 7 Things You Need to Know About the Roth IRA for 2010, Roth IRA Conversion Tax Rules, Can You Undo a Roth IRA Conversion?
1. Rules on Income Limits.
Whether you are filing as an individual or married filing joint, the adjusted gross income level of $100,000 will become nonexistent for the Roth IRA conversions of 2010. For higher wage earners, this is a prime opportunity to convert money into the Roth IRA to allow your money to have tax-free growth at retirement.
2. You don’t have to wait until 2010.
For wager earners that make less than $100,000 adjusted gross income, you can actually convert now. With the market being down what it is this might be an excellent time to convert since you will be paying less income tax on the lower account value. By waiting until 2010, and if you are able, you may be having to pay a higher tax bill with market appreciation. If you convert too soon, you can always do an IRA recharacterization by October 15th of year you convert.
3. 2010 is the year but not the year the tax is due.
While 2010 is the actual year that you will be able to convert, the income to be claimed can be deferred until 2011 and 2012. Expecting a vast majority to take advantage of this, the IRS has set up special provision on how the tax will be paid. The IRS has granted you the option to claim 50% of the conversion amount as income in 2011 and the remaining 50% in 2012. Keep in mind that this is only in 2010. After 2010 the taxes will all be paid in full the following year going forward.
If you elect to pay the tax over the two year period, keep in mind that the tax rate is determined for that year only. Example, in 2011 you will pay the tax based on your tax bracket for that year. If your income were to somehow sky rocket in 2012, then you will be paying more in taxes that year for the conversion.
What if husband and wife want to convert? Each IRA(s) is tied directly to the Social Security number of the account owner. What that means is that if a husband wants to convert his IRA’s and the wife does not, that’s okay. Further more, if both want to convert, then the husband can choose the two year option on paying the tax and the wife could choose to pay her tax in 2010 (or vice versa). Remember that you have to do one or another. For example, if the husband has multiple IRA’s that he is looking to convert, he can’t choose to pay the tax this year on one IRA, then defer the other IRA for 2011 and 2012.
4. You can save taxes now.
Knowing that the event is just around the corner, and if you know that you are going to convert in 2010, it might make sense to go ahead and start accumulating the tax money now. Since you will be taxed at ordinary income levels you can get a sense of what the tax bill will actually be at the time of conversion. So why not add a little extra to your emergency fund to insure that you have enough to pay the tax bill for this exciting event?
5. Convert but Can’t Contribute
2010 Conversion
Just because the conversion limit of $100,000 AGI is lifted, doesn’t mean that the income restrictions are lifted for new contributions into the Roth. If you’re over the phase out limits of the Roth IRA contribution, you will not be able to contribute new money to the Roth. There is a backdoor approach to this and that allows you contribute to a non-deductible IRA and then right immediately after wards convert it to a Roth IRA and avoid all taxable consequence. It’s a nice loophole that still allows you to continue to contribute to the Roth and benefit from the tax-free money.
6. Convert Traditional IRAs and Old 401(k)s.
The 2010 conversion is not limited to just your traditional IRA. If you have any old 401(k)s or any other retirement plans from a previous employer, those will also be allowed to convert as well. Might be a good idea to convert them all. Be conscious if you are converting after tax contributions in an IRA (non-deductible IRA). The tax rules can get a bit complicated. Follow these steps to figure out how much tax you will owe.
7. What’s the Cost Basis?
If you have an old 401(k) that you have rolled over into an IRA, the question might be what do you use as the original tax basis? In the face of the 2010 conversion or any conversion in general the basis, or the amount that you will be taxed on, is the amount of the account at the time of conversion. For example, if you had an old 401(k) that was worth $45,000 and rolled it over into an IRA, and now that IRA is only valued at 25,000, the 25,000 is the amount you’ll use for your basis. If you elect to do the conversion at 25,000 and then as the year goes by and the account drops more, the option might able to do what’s called an IRA recharacterization.
Update: Check out my latest post that shares some real life scenarios and tax consequences of converting a Traditional IRA to a Roth IRA. Also, check out this post I found on different Roth IRA conversion calculators.
*Restrictions, penalties and taxes may apply. Unless certain criteria is met, Roth IRA owners must be 59 1/2 or older and have held the IRA for 5 years before tax-free withdrawals are permitted.
Securities offered through LPL Financial member FINRA SIPC.
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I would like to know how converting to a Roth will effect your Medicare premium if the total income will be over $200,000—Would this effect both spouses if both are on Medicare? Also would selling a house affect Medicare premiums also?
In the past if you are married filing separately you didn’t qualify for a Roth IRA. As a married filing separately will I be able to take advantage of the 2010 rule?
Great article…right to the point. Another good source for information is http://www.2010RothConversion.com
Is a 403B like a 401k in being able to roll it over into an IRA and then into a Roth-IRA? I’m not certain that at 67 years of age it would be worth while to switch. It seems as though the lower middle class older person may not benefit from the switch unless I misunderstand .
@ Judith
Yes, you sure could roll a 403b into an IRA and then convert to a Roth. Being 67 years of age, I would agree that converting to a Roth might not be the most advantageous thing to do. The only benefit would be if you were looking to use it as an effective estate planning tool. For example, you would pay the tax now so that your heirs would have a tax free inheritance. Some of my clients plan on doing this, but those are special circumstances that would not apply to everyone.
I’ve got a traditional 401(k). Is the 2010 conversion applicable here? In other words can I convert the 401(k) to a Roth 401(k)? If so, is there anyway to ascertain how much tax I’d be on the hook for?
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@ DanIzzo
As it stands right now, there is now provisions that will allow you to do this. Pure speculation on my part, I could see the IRS eventually allowing this. If they do, a blog post is sure to come
I just wanted to say THANK YOU for putting the ROTH IRA conversion in 2010 in layman’s terms. I’m trying to decide do I convert this year or next and your info was very helpful. I’ll be passing this onto my friends as I’ve looked at IRS.gov and other places and not found something I could readily understand until now. THANKS!!
@ Jen
You’re very welcome! The hardest part of my job is taking a complex and sometimes confusing process and making it simple. Sometimes it’s even hard for me to understand
Thank you so much for your kind words and I look forward to offering more useful tips!
I am just over 70 1/2 years old and retired. My adjusted gross income in 2009 will be over $100,000 of which a very small amount (less than $2000) is considered W-2 Income.
I have a 401(k) with my former employer containing contributions that have already been taxed as well as contributions that have not yet been taxed.
I would like to open a Roth IRA in 2010 and roll the already taxed 401(k) portion into it. Then I would like to roll the yet to be taxed portion of the 401(k) into a Standard IRA. Is it possible to do both these things and would both be non-taxable events? I realize that future distributions from the Standard IRA will be subject to tax.
Thanks, Werner
@ Werner
If your 401k consists of pretax contributions as well as after tax contributions, then you would definitely we able to do what you are describing. The only thing to be aware of is when you do go to rollover your 401k into the traditional IRA, since you are over the age of 70 1/2, they will most likely take out your RMD’s. If you do it in 2009, this won’t be the case since they have been suspended, but they should resume in 2010.
Jeff,
I can’t open a Roth IRA in 2009 because my income is greater than $100,000. So if I can’t open a Roth IRA , I can’t roll anything into it. It appears that I must wait until 2010, the one year for which the income limit will be suspended, before I can open a Roth IRA and roll the already taxed portion of the 401(k) into it, correct?
I suppose I could roll the pretax contribution portion of the 401(k) into a Standard IRA in 2009.
Both events should be viewed as non-taxable events by the IRS — I hope?
Thanks, Werner
@ Werner
Sorry of the misinformation. You’re absolutely right. Since you are not currently eligible to open a Roth, you would not be able to do the rollover in 2009. Do you expect your AGI to be the same for next year as well? If that’s the case, you might have to work some more loopholes to get the after tax 401k money into the Roth IRA. To clarify, in 2010 the AGI limits are lifted to do a conversion, but the same phaseout rules apply to be able to contribute to a Roth. Simply put: Just because you can convert, doesn’t mean you can add new money. You may have to do the conversion first to make sure the Roth IRA is open and then roll over the after tax portion.
Everything would be considered nontaxable by the IRS up until you initiate the actual conversion, so yes.
Your welcome, Jeff
How about the early withdrawal penalty? Does that come into play here, or is just the tax on the amount converted, depending on your bracket?
@ jimmyt
The early withdrawal penalty does not apply in regards to a conversion. Just the tax as you indicated.
can I convert a Keough to a Roth IRA?
A couple of questions: Is the 50% tax per year 2011 & 2012 only for 2010? If you convert in 2009 can you spread it over 2010 & 2011?
Do you pay self employment and or Social security etc on the amount or only the actual income tax?
Can you use funds from your new Roth to pay the conversion income taxes or is that considered a distribution?
Also – the 100,000 limit for 2009 – is that after the conversion? In other words if someone has $90,000 AGI in 2009 are they limited to converting on 10K from a regular IRA to a Roth?
@ Jon
Yes, the ability to spread out the tax on the conversion is only for 2010 only.
You just pay the income tax on the conversion. You have the option to have taxes withheld from the account to pay for the conversion. Typically, I wouldn’t recommend this because you are taking money out of the Roth. If you can pay for it with other means that would be the most beneficial. You got time to save
The $100,000 limit is just based on your AGI and has nothing to do with the conversion amount. Example: Your AGI could be $98,000 and you could still convert a traditional IRA with a balance of $35,000 with no problem.
Hope that answers all your questions!
Pardon the newbie question, but I have the following situation.
I am on the younger side, make less than 100k and have a 401k account with a company that I have been for the past 3 years. They give me a match so I am continuing to contribute. The account has been hit badly by the recent market downturn and is down to about 12k, I would like to convert to a Roth.
Can I take the existing moneys and create a Roth out of it while continuing to contribute to my 401k. I guess this would not be a conversion per se, but a move of funds. Is this possible? Do I have any reason to wait to do this, considering that my wage/taxable income will continue going up. (Assuming I am still employed).
Thanks!
No apologies needed. Your idea is not a bad one to consider, but unfortunately while you are still employed by your company you will not be able to do a conversion. You would have to be separated from them to do so.
I am 66 years old, if did a partial rollover from my 401k to a roth ira converion and pay the taxes can I start taking withdrawals before the five year rule?
@ Reginald Spengler
Thanks for visiting the blog. Sorry for taking some time to reply. I was getting conflicting information on your situation and wanted to verify.
The amount that you “convert” becomes immediately available to you since you have met the 59 1/2 requirement. If you have any earnings that result from the conversion, those still have to satisfy the 5 year rule. Hope that helps!
Let’s say I convert $100K in 2010. Is that entire amount added to my income in 2010, the taxes computed, and then the taxes are paid over the next two years? Or, is $50K added to my 2010 income, and $50K added to my 2011 income, with the taxes being computed separately for each year? How this is implemented may make a significant difference for some people.
@ David Kelsey
You’re absolutely right about it making a significant difference. The amount that you convert in 2010 is deferred as income to be split over 2011 and 2012. There have been many different interpretations of the code, but that seems to be the most up to date that I’m seeing. Keep in mind that the split in 2010 is optional, meaning you don’t have to do it. Although, I’m sure most will. Also, 2010 is the only year that allows the split.
I am 65 and will retire in 18 months. Also married. How do I calculate the attractiveness of a conversion? I have a 7 figure IRA and expect to leave it to my kids and delay any withdrawls until 70 1/2. But what if i need to draw it down sooner, how do I calculate the after tax breakeven point? Doesn’t it depend on life expectancy and other variables?
@ B. Schaffer
As it stands right now, conversion calculators are being created as we speak. Other than that, I haven’t found a calculator that I’ve put much faith in. If and when I find something, I’ll be sure to post it here on the blog.
For other clients that are in a similar situation, we typically have set up a joint meetings with the CPA and the estate attorney and done some pre-planning for the event.
With a such a sizeable amount, careful tax planning MUST be implemented. One final point to mention is that once you turn 70 1/2, the portion of your retirement accounts that are determined to be your RMD’s will not be allowed to be converted. That amount must be withdrawn and then the appropriate tax is to be paid.
Just to be clear, if your ordinary income is $90,000 and you are converting $400,000 from your IRA to your Roth IRA, is the tax based on your $90,000 tax bracket or your $490,000 tax bracket? If it is the combined tax bracket, what is the maximum ordinary income limit you might want to hit in doing the conversion that makes tax sense.
I am older than 60 yrs old, and I have an existing Roth IRA > 5 yrs old; can I invoke the 2010 401K conversion into that ROTH IRA and not have the 5 yr wait
for withdrawl of earnings from the ROTH IRA
Please clear up an ambiguous (to me) reference in the option for 2010 Roth conversions: does the tax due in “2011″ refer to the return due April 15, “2011″ for the 2010 tax year or does it refer to the return due April 15, 2012 for the “2011″ tax year? Also, will I be able to use realized tax losses from other stock investments to offset the Roth conversion tax bill? Thanks
@ John
The tax is based on the $490,000. That’s why it might be advantageous to do the conversion in 2010, so that you can defer the income over 2011 and 2012 tax years.
Personally, if I was dead set on doing the conversion, I would want to pay the least amount of tax as possible. It might make sense in your situation to convert small chunks over several years.
@ Harry
My interpretation of the rule is just that. Since you’ve met the 59 1/2 age limit, you will be free to take the monies that you convert immediately.
I just wrote a more recent post that addresses that topic.
http://www.goodfinancialcents.com/roth-ira-qualified-distributions-withdrawals-5-year-rule/
@ A Carter
Don’t worry, it was ambiguous to me as well. The dollar amount that you convert in 2010 will be deferred income that you can spread evenly between 2011 and 2012 (you don’t claim any income in 2010).
Since the conversion is treated as ordinary income and not a capital gain, the only amount that you will be allowed to offset is the typical $3000 capital loss. That’s it.
Hope that answered everybody’s questions.
If in 2009 you have an adjusted gross income of $90,000 (under $100,000 limit) what is the maximum amount I can convert to a Roth IRA? Am I limited to the amount that would after tax max my adjusted gross income at $100,000? For instance $40,000 Ira at 25 % tax bracket = $10,000, which added to my AGI of $90,000 = $100,000?
@ John Murray
If you are below the AGI limits, there is no limit to what you can convert. With your example, with an AGI of $90,000 you would be able to convert the full $40,000. The conversion amount does not affect the AGI limitations. Furthermore, the conversion amount does not affect the amount you can contribute to a Roth IRA either (just in case you were curious).
Can I convert a SEP IRA to a Roth?
@ Bob
You absolutely can if it is an old retirement plan. If you are currently contributing to it, you will have to wait until you either retire or separate from service.
With doing this, does existing 401k accounts enter into the picture as far as cost-basis or tax considerations? Thanks.
No. Existing 401k balances have no impact.
If the AGI of a couple who is married filing jointly is greater than allowed for a Roth IRA what can an individual do if his employer does not offer any 401(k) option?
@ Pat
If you don’t meet the phaseout limits of the Roth IRA, then you are still left with the traditional IRA.
Can I pull money out of a Roth IRA for my sons education expenses even though I’m under 591/2 without penalty?
@ Scott
You sure can. You avoid the 10% penalty, but still have to pay the appropriate tax. It will be treated as ordinary income.
I just learnt about the 2010 Roth IRA conversion rule and I can’t wait for 2010 to arrive. So would I be able to convert my 401(k) (or part thereof) into a Roth IRA in 2010? I understand that I will have to pay taxes on all money transferred.
@ Rohan
You will only be able to convert your 401k if you are no longer employed by the same company. The conversion is just allowed for previous 401k’s (and other old retirement plans) and IRA’s.
If converting in 2010 can the tax bill be spread out over 3 years 2010,2011 & 2012? if AGI is less than $100.000
Jeff,
A great article and great follow up answers. I see that you have kept up with this info session for 6 MONTHS. Not a very common service. Thanks.
I have a question about the actual time in 2010 you can effect this change. Is anytime after 1/1/10 time to contact your brokerage and make the switch or is there a month in 2010 where this has to happen. The sooner I do this, the better chance that I can avoid any significant tax on my IRA to ROTH conversion since I am still at about 9% loss on my initial investement.
Also, is there a limit in years to this opportunity for high earners to do the back door IRA to ROTH conversion or no time limit as far as your experienced eyes can see.
Thanks.
Jared.
@ Jared
You can initiate the actual conversion anytime in 2010. If you’re trying to lock in a lower value, then the January 1st will be your best best (provided the market continues to rise). If you do it too soon, you can then do a recharacterization. You can read more about the recharacterization here: http://www.goodfinancialcents.com/ira-recharacterization/. There are some key issues about the recharacterization that need to be aware of.
As the law stands right now the backdoor through to the Roth through the nondeductible IRA is set. Could that change? Absolutely. I just attended a conference where this topic was brought up and the hunch was you won’t see it change anytime in the near future. Time will tell.
Say I have 100K in a non-dedutible IRA, 100K in an old 401K (from a previous employer) and 100K in a 401K (with my current employer). If I convert the 100K in the non-deductible IRA into a Roth in 2010, what is the amount on which I will need to pay taxes? Thank you.
The only thing you have to be concerned about is your IRA money, if that’s all you want to convert. You can leave the monies in the old 401k and they won’t factor in the equation.
This is in regards to the Rohan question and answer on 8/19 and 8/22/09:
I contacted fidelity investments, the manager of my husband’s 401K – he is still working and contributing. He is allowed to take an in-service distribution from the 401k. He has after tax contributions. They told me that in order to take the after tax contributions, a certain amount of pre-tax contributions would also need to be taken. They told me the after tax contributions could be rolled into a Roth IRA and the amount of pre-tax contributions that would need to be taken out could be rolled into a traditional IRA.
QUESTION: In your response to Rowan on 8/22 you stated,
” You will only be able to convert your 401k if you are no longer employed by the same company. The conversion is just allowed for previous 401k’s (and other old retirement plans) and IRA’s.”
From my understanding, I think my husband will be able to take an in-service distribution and convert both after-tax 401K money to a Roth IRA in 2010, and a corresponding amount of per-tax money to a traditional IRA. Please respond. Thanks.
Rohan Pathak August 18, 2009 at 4:15 pm
I just learnt about the 2010 Roth IRA conversion rule and I can’t wait for 2010 to arrive. So would I be able to convert my 401(k) (or part thereof) into a Roth IRA in 2010? I understand that I will have to pay taxes on all money transferred.
Re: Jeff Rose August 22, 2009 at 9:42 am Twitter: @jeffrosecfp
@ Rohan
Let’s say that my ordinary income is $140,000 and my conversion amount is $200,000. Without the conversion I would be eligible to contribute to my ROTH IRA directly. Does the conversion count against the limit to contribute to a ROTH IRA?
As long as you still don’t exceed the Roth IRA Phaseout Limits, you will still be able to contribute to a Roth even after doing the conversion.
Jeff,
I have a 401K with my ex-employer. I’ve been unemployed for the past 2 years. What will my tax rate be if I convert to the roth? When should I convert?
Thanks,
Abe
Your tax rate on the conversion is based on the year you actually convert. Doing so in a year that has little to no income is advantageous but only if you can pay the tax outside of the account (in my opinion).
Jeff,
I have after tax contributions in my 401k that are in a loss position. My plan is to convert these directly to a roth IRA in 2010 since the IRS code and my company’s plan allow that. Can I deduct the loss on conversion? I have no IRAs.
I came across your website and was wondering if you might be able to help me with a question I’ve been searching for regarding the rules for calculating cost basis on the 2010 Roth Conversion. I have been contributing for several years to a Traditional IRA. I have about $10k that was contributed to the IRA as deductible in the original tax years. I have since contributed about another $20k over the years but these were done as non-deductible contributions (I filed form 8606 with my tax returns) because I no longer qualified for deducting my IRA contributions. So I have roughly 2/3 of my original cost basis as non-deductible contributions and the other 1/3 was deducted. Because of the recent market turmoils the value of my IRA account has decreased by around 30% and now the current value is only about $20k, whereas I had originally contributed a total of $30k ($10k was deductible contributions and $20k was non-deductible). Can I use my non-deductible cost basis of $20k and not have to pay taxes when I convert this Traditional IRA to a Roth IRA in 2010 since the amount I am converting is the same as my non-deductible cost basis? Any information about how cost basis is calculated and in particular when the IRA account has lost money from the original contribution amount would be greatly appreciated!
Hi Jeff,
Thanks for the great article. I read through all the comments and your answers. Still have two little questions for you. I would like to convert IRA to Roth, but do not want to convert the whole account. Is it allowed that I only convert partially of a IRA? If I convert it now, is the income tax due for the tax year of 2009 or 2010? Thank you in advance!
@ Don
Yes, you can convert only half. Check out this post that I used an example of only converting half: http://www.goodfinancialcents.com/2010-traditional-ira-to-roth-ira-conversion-tax-rules/
If you convert in 2009 (this year) then it would be added to your income for ‘09 and then pay accordingly when you file April 15th next year.
Jeff:
I have a 401k account with a former employer (Account #1) currently valued at approximately $50K and a 401k account with my current employer (Account #2) valued at approximately $45K. I currently make an income of approximately $165K.
If I decide to at least transfer the funds from Account #1 into a Roth IRA, what steps do I have to take now in 2009 and/or in 2010? Do I have to transfer the funds from Account #1 now (2009) into a “rollover IRA” and then convert the rollover IRA to a Roth IRA in 2010? Alternatively, can I wait until 2010 and rollover my funds from Account #1 directly into a Roth IRA (if that’s permitted)?
Thanks in advance for your thoughts on the matter.
Excellent article. As a ‘high’ income family, I am quite confused and this helped me out.
Currently my wife (30) and I (36) bring home about $290,000 a year and have about $225,000 in a rollover IRA. As our tax bracket is currently high due to income, I was wondering if rolling into a Roth would be beneficial. My gut says no, because as we are already in the highest bracket, we will be paying a large amount of taxes and when we retire, we will should be in a much lower bracket. However, the growth of 225,000 (Post taxes) over 30 years could be substantial and not having to pay any tax 30yrs of gains is quite desirable. Another concern is that tax rates are going to be much much higher in 30 years which would impact us, but that is debateable.
I was wondering what your thoughts are on how I should proceed. Thank you for your advice and your great column
Hi Jeff,
Is the “tax loophole” statement below accurate ? I thought the conversion tax is a pro-rata basis of all your IRA accounts? If you already have a large IRA, funding the max amount annually into a non-deductable IRA ($5k or $6k), and then converting it to a Roth would I think only relieve a very small portion of tax liabilty. Or is there something I’m missing?
Thanks
“There is a backdoor approach to this and that allows you contribute to a non-deductible IRA and then right immediately after wards convert it to a Roth IRA and avoid all taxable consequence. It’s a nice loophole that still allows you to continue to contribute to the Roth and benefit from the tax-free money.”
Thank you for putting out this information! I have been looking forward to 2010 to convert an old 401(k). I’m 35 and have ~45k in the old account. However, now I am reconsidering given possible negative consequences to my husband’s retirement savings. The conversion will push our joint income over the phase-out limits. My husband works for a small employer and the ROTH is his only retirement savings vehicle (no employer-sponsored plan). Also, we are hoping to buy a house within the next year or two, and the tax hit may affect our ability to make a 20% downpayment. I’m worried I’ll kick myself if I miss this rollover opportunity. Any advice?
Jeff and all the others,
I am convinced that if you have more than 15 years until you retire that converting a Traditional-IRA to the ROTH-IRA next year is the best thing to do.
My situation: I am 50-years old. I have approximately $240K in a T-IRA with about $30K of that being non-deductible contributions (contributed after tax). I am currently in the 28-percent tax bracket. I plan on converting the first week of Jan 2010 and selecting the option to pay the taxes equally in 2011 and 2012. Under current tax rules this additional income to be taxed $105K in 2011 and $105K in 2012 will push me into the 33-percent tax bracket. However, right now come Jan 1 2011 there is a roll-back on the tax brackets back to the pre-2001 levels and the two upper brackets jump to 35 and 39.4 percent.
ASSUMPTION: I am assuming that Congress will not allow the rollback to occur (at elast in 2011) because the economy will not have fully recovered and the rollback not only affects the marginal tax brackets but also many of the taxcredits that small businesses and others have taken advantage of over the previous 10 years. Time will tell on this assumtion over the next 12-months.
Currently, my estimated tax (federal and state) hit will be about $40K more each year (OUCH!!) in 2011 and 2012. This is a substantial bill and has to be planned for. One option is to increas my withholdings a little more from the paycheck. (Either additional funds need to be withheld or estimated quarterly payments are required, or both, because of IRS rules.) I have already set aside 30K of outside funds and have all of 2010, 2011 and into 2012 before the first $40K of additional tax is due. Additionally, I plan to file for an extension for the 2011 tax year so instead of paying in April 2012 (for 2011 taxes) I can wait until Oct 2012 to either pay or recharacterize the conversion back to the T-IRA. This is a safety-valve feature of the entire process.
The real benefit to the conversion is that the bottom line value of the account is all mine and the amount that it grows until retirement is all mine as well. (Unless COngress changes something.)
The one variable that no one can really predict is what tax-bracket will you be in when you retire and begin to draw on the funds. My assumption: Tax brackets will be higher in 15-20 years than they are now for a variety of reasons. By paying the taxes now on the conversion I avoid any additional payments in the future. From all the various calcualtors that I could find, and just using todays tax brackets, and that regardless of ROTH or T-IRA account would grow the same way. It appears that if I am in a hypothetical 23-percent tax-bracket or higher that the ROTH conversion comes out ahead over the T-IRA assuming a 20-year window before I begin to draw down on the funds.
Guideline: If you think that your tax-bracket will be no more than 5-pecent less than the tax-bracket that you are in now, then converting comes out ahead. Congress can make any number of changes to the tax code between now and when we draw down on the ROTHs. My guess is that tax brackets will be higher.
I am supportive of the conversion, but the tax-bite has to really be plannned for and cannot be taken lightly. I would also suggest not using any funds from the IRA conversion to pay the taxes for a number of reasons that is beyond what I would like to get into here. If the window is greater than 15-years it is absolutely worth it, if the window is less than 10-years probably not. The “pivot-point” appears to be right at 12-years. Any time horizon between 10 and 15 years is really an individual, case-by, case basis and depends on other retirement fund sources and the ability to pay the tax on the conversion from outside sources.
Comments?
Regards,
TJB
“Additionally, I plan to file for an extension for the 2011 tax year so instead of paying in April 2012 (for 2011 taxes) I can wait until Oct 2012 to either pay or recharacterize the conversion back to the T-IRA. This is a safety-valve feature of the entire process.
”
Opps, that is not correct. What it actually should read is that “Additionally, I plan to file for an extension for the 2010 tax year so instead of paying in April 2011 (for 2010 taxes) I can wait until Oct 2011 to either pay or recharacterize the conversion back to the T-IRA. This is a safety-valve feature of the entire process.”
Regards,
TJB
In order to determine if converting traditional IRA to Roth will cause you to move to the higher tax bracket, you need to know the minimum taxable income (after deductions and exemptions) the next higher bracket will start at. For example, according to IRS, the maximum taxable income for a married couple filing jointly at the 25% rate for the 2009 tax year is $137,050. Higher than that, they are in the 28% bracket. It is not possible to know in advance what the maximum income will be for for 2010, 2011, and later as it will be adjusted for inflation. If, say, your 2010 taxable income from non-IRA sources is $100,000, that puts you in the 25% bracket. If you convert more than $80,000 worth of traditional IRA to Roth in 2010, you will have a taxable income of over $180,000 and that will put you in the 28% bracket if you report the entire conversion amount that year. On the other hand, if you decide to report half ($40,000) in 2011 and half ($40,000) in 2012, you stay in the 25% bracket these years if the tax brackets are adjusted upwards by at least 2.5% inflation rate each year. So we need to estimate what our taxable income is going to be before the conversion and how much we can convert to avoid being bumped up to the higher tax brackets.
Gary,
You make a very good point and for some people it would make sense to convert in stages over several years to stay in the lower marginal tax bracket. However, I believe that if an individual is close to the top of their existing marginal tax bracket it makes sense to convert becuse if it takes more than 5 years to convert in portions the Congress is likely to change the marginal tax brackets within that time frame anyway. Soemtimes it is better dealing with the devil that you know than the devil that you don’t know.
However, folks do have to understand how the marginal tax brackets work. Whatever tax bracket a person is currently in, any additional income up to that marginal tax bracket limit is taxed at that same marginal rate. Should an individulas income push them into the next marginal tax bracket, say from 25-percent to 28-percent, does not mean that their entire income is now taxed at that 28-percent rate. For example, if an individuals income pushed them from the 25-percent into the 28-percent tax bracket by $10,000, then the individual would have to pay 28-percent on that $10,000 or $2800, whereas the the previous $10,000 of income was taxed at 25-percent and paying $2500.
From the numbers that I have seen on various websites I anticiapte that the final inflation number for 2009 will show a near zero inflation rate for 2009 (if not negative). The upward limit on the marginal tax brackets will probably not move upward very much, if at all.
The real threat to the marginal tax brackets is that the law that Pres Bush signed in 2001 expires on 1 Jan 2011 (after its 10-year life) and not only do the marginal tax brackets rollback to their 2001 levels, but all the various tax credits that individuals and small business have enjoyed for the past 10 years will disappear as well. This will mean that the 10% bracket disappears altogether. I think (but have not confirmed) that the others brackets breakdown as follows: The 15% remains the same, the 25% moves to 28%, the 28% becomes 33%, the 33% become 35%, and the current 35% becomes 39.6%. The upper limits on the marginal tax brackets will probably move a little higher as well.
(Here is my guess, or prediction, on what will happen —- Congress will see that the economy has not yet recovered enough to allow the marginal tax brackets to revert back to their 2001 levels. They will also not have put forth any time and effort to work out what a new tax bill should contain or see which tax credits are working and which need to be changed. Therefore, Congress will just change the sunset date on the rollback from 1 Jan 2011 to 1 Jan 2013. This will push the rollback to occur and coincide with when the new President takes office should Obama lose reelection. If Obama wins in 2012, Congress will move the sunset date to some point further down the road so that he and that Congress can address it during Obama’s second term. —- IMHO.)
By the way, I did make my 2010 T-IRA contribution and I did complete a conversion to a ROTH-IRA last week. The final conversion value was about $250,000 with about $30,000 of it in non-deductable contributions. Now the process begins to save for the federal and state taxes that will be due in the 2011 and 2012 tax years. Estimated to be about $45,000 in taxes each year. — OUCH !!!
Regards,
TJB
Regards,
TJB
The new Roth IRA Conversion rule is a great one to take advantage of this year. With taxes in the long term going only one way (up!) converting now can make a lot of sense for those with higher incomes
FollowUp:
The Inflation Rate for 2009 turned out to be negative — (-0.34-percent).
http://inflationdata.com/Inflation/Inflation_Rate/HistoricalInflation.aspx?dsInflation_currentPage=0
The last time that this happened was 1955.
Regards,
TJB
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