If you’ve been around the blog, I’m sure you’ve noticed that I’ve written much on the Roth IRA 2010 conversion event.  It’s been getting a ton of buzz as many are eager to enjoy the tax free benefits of the Roth IRA.  As with anything, just because your neighbor is doing it, doesn’t mean you should.   We took a closer look of the some of the unforeseeable consequences of the Roth conversion and uncovered some potential pitfalls that you may have if you convert without knowing all the facts.  Another important issue for parents who have children going to college soon is the impact that a Roth conversion can have your kid qualifying for financial aid.  Tax free is nice for down the road, but converting too much could leave you with a hefty tuition bill.

Benefits of the Conversion

As of now, you won’t pay any taxes for any money in the Roth.   And if you’re a believer that taxes having a greater chance of going up then down, then why not pay the tax now and enjoy tax free growth later on?  Another benefit pertains to estate planning.   Seniors that reach 70 1/s are not required to take out their required minimum distributions in a Roth and if they never use the money; can pass the money on to their heirs tax free.

Roth Conversion and Your FAFSA

There’s no “if’s”, “and’s”, or “but’s” about it, a conversion is what is its and that “is” taxable.    Many forms of scholarships, grants, and loans are based on the household income.  In the event, you do a sizeable conversion, you’ll see the your AGI rise and the financial aid office take a closer look.

The dollar amount you convert must be reported on your FAFSA (Free Application for Student Aid).   Here’s a definition of the FAFSA form straight from their site:

The Free Application for Federal Student Aid (FAFSA) is the form used by the U.S. Department of Education to determine your Expected Family Contribution (EFC) by conducting a “need analysis” based on financial information, such as income, assets and other household information, which you (and your parents if you are a dependent student) will be asked to provide. The form is submitted to, and processed by, a federal processor contracted by the U.S. Department of Education (ED), and the results are electronically transmitted to the financial aid offices of the schools that you list on your application.

FAFSA is the application used by nearly all colleges and universities to determine eligibility for federal, state, and college-sponsored financial aid, including grants, educational loans, and work-study programs.

Bottom line it’s all about the Benjamin’s and how many you have of them.  If your AGI is higher because of an sudden increase due to a conversion, it could mean less financial aid to pay those tuition bills.

A New York Times article offered an example. Take a hypothetical family of four with total 2010 income of $75,000 and one college student. For every $10,000 of taxable income stemming from a Roth conversion, the parents’ expected annual contribution to that student’s education would go up by $3,200 in a FAFSA estimate.1

Financial Aid Looks at More than One Year

When it comes to your income, financial aid considers more than just one year.   As you know (or you will now), the default election to pay the tax on the conversion is to defer this year (2010) and split the remaining portions 50/50 over 2011 and 2012 tax years.  Essentially, doing a conversion today could affect your chances of financial aid well until 2013.

What if Your Kids Are Young?

Then regarding college and financial aid, it shouldn’t matter.   Now that still doesn’t mean that a Roth conversion is right for you.

The potential long-term benefits of a Roth IRA conversion are considerable. Double check with your financial advisor or tax professional to see if the decision is appropriate before you elect to make the move.


1 bucks.blogs.nytimes.com/2010/04/16/how-a-roth-i-r-a-conversion-can-hurt-financial-aid/ [4/16/10]

Creative Commons License photo credit: Quack the Wooley Duck


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