Over the past week we’ve been writing quite a bit about retirement accounts, which ones are better for different situations, and talking about what the Roth IRA contribution limits are. Now I want to talk about another hot topic in retirement accounts, the 2010 Roth IRA conversion.
In case you haven’t heard all the buzz, this year marks a one time Roth IRA conversion event in which people can convert their traditional IRA’s, SEP IRA’s, Simple IRA’s, old 401k’s, old 403b’s into a tax free Roth IRA account. Because of the conversion event, waves of people are expected to take advantage this year and convert their traditional taxable investment accounts into tax free Roth IRA accounts.
Is It A Good Idea To Convert My Traditional IRA To A Roth IRA?
Before you even go down the road of converting your traditional taxable accounts, you’ll need to think about whether or not converting them is a good idea for your situation. There has been a lot of talk about it throughout the blogosphere, with some saying it’s a great idea for most to have their money grow tax free, while others aren’t as enthused because it seems like a way for the government to collect tomorrow’s tax income today, at a higher rate. As always consulting a financial professional before you make any moves is a good idea.
Among the things you need to consider:
- Do I want to pay tax now or later? Depending on what your tax rate is currently vs. when you retire, your amount of tax can vary quite a bit. The problem is, it can be hard to guess what tax bracket you’ll fall into in the future, much less predict if tax rates will go up in the future.
- Is my income too high to contribute or convert to a Roth IRA in the future? If you want to do a bit of tax diversification and your income is currently too high to contribute to a Roth IRA, this year may be one of your few chances to convert your traditional taxable account to a Roth.
- Do I want to spread out my tax liability from converting? As part of the conversion event people who convert will be able to spread out their tax liability over 2011 and 2012.
Benefits Of The 2010 Roth IRA Converson
There are quite a few benefits of converting to a Roth IRA this year
- $100,000 AGI rule removed: 2010 is big for so many because the $100,000 MAGI rule is lifted, making a conversion possible for even higher earning singles and couples. Previously only singles and married couples making less than $100,000 were able to convert.
- Tax doesn’t have to be paid 2010: 2010 is the year that you’ll actually convert to the Roth IRA, but the income to be claimed on your taxes is able to be deferred until 2011 and 2012. You can claim 50% of the conversion amount as income in 2011 and the other 50% in 2012. Remember, this stipulation is only good for the 2010 tax year, and then goes away.
- You can convert a 401k directly to a Roth IRA: If you have a 401k from an old employer, or another old retirement account, you can convert those this year as well.
- Tax free growth of assets, and tax free withdrawals: Converting means the money will grow tax free, and won’t have minimum distribution requirements once you turn 70 1/2.
Contribution Income Limitations Still Exist For New Roth IRA Contributions
Even though high income earners can convert their existing retirement accounts in 2010, that doesn’t mean that new contributions to their converted Roth IRA are allowed. If you’re over the IRA contribution phase out limits, you won’t be able to make new contributions to your Roth IRA.
How To Convert To A Roth IRA
Converting your IRA to a Roth IRA is going to be very similar to rolling over an account from an old 401k to a rollover IRA. If you’re not changing brokers or investment houses it may be as simple as filling out a form. The key is to contact a financial professional who can give you advice for your specific situation.
Are you going to be rolling over a Traditional IRA into a Roth IRA this year? If so, do you plan on deferring the taxable income into 2011 and 2012? If not, why are you decided not to convert? Tell us your story in the comments.
I did a conversion last year, and it was really a “crystal ball” type of situation.
As I remember,the biggest factor for me was trying to decide what tax bracket I would be in at retirement compared to now.
I mulled it over for quite some time before pulling the trigger on it.
As I remember, I sacrificed approximately $1500 in return money from last year by doing so.
If you think you’ll be in a higher tax bracket at retirement, then its a good idea to do it now, in my opinion.
David/Yourfinances101´s last post ..Don’t Be a Mule: Fees
In a word, no. I’m part of the dialog at Sam’s site you linked to.
The tough part of this conversation is that there are so many variables to ponder.
Too many posts ignore the dry, boring math which needs to be at least touched on to analyze one’s own situation.
For a couple today to retire and be at the top of the 15% bracket, they would need $86,700 taxable income. This translates to over $2 million in pretax accounts to withdraw this number.
This alone is enough to suggest that if one is in the 25% bracket today, they’d need a huge next egg, pretax, to risk retiring in even the same bracket.
Sorry, this is a soapbox topic for me, I’ll close with this thought. All data points towards low savings rates, the risk that few are ready for retirement as they approach 60, etc. The number today that seem to be near that magic $2M at retirement is pitiful, today, less than 5%. Remember, even a high wage earner can only pack so much into pretax accounts.
JoeTaxpayer´s last post ..A Roth Roundup
Taxes, taxes, taxes.
Something worth looking at but you better be sure its the right decision.
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I like the idea of having some money in the Roth just in case it’s needed for living expenses, then at least there’ll be no tax on the contribution portion. The problem I have stems from the same issue, if it’s less expensive to withdraw funds, we might be tempted to do just that.
The purpose of tax sheltered plans is retirement, and for that reason alone it may be worth it to keep the funds as far away from us as possible. Back in the days of employer managed defined benefits plans workers could build up money they never knew about and when they retired, it was there waiting for them. We have to come as close to that arrangement with self-directed plans as possible.
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NORMAN SPECTOR says
CAN I CONVERT AN IRA TO A ROTH PRIOR TO AN RMD IF THERE ARE ENOUGH FUNDS FOR THE RMD?
You can do it prior in terms of time, but you must do the RMD math before the conversion. In other words, the 2010 RMD is based on the ’09 year end balance, and you need to be sure that amount is withdrawn by the end of this year.
Joe King says
What tax rates are used for a 2010 conversion? Is it locked at the 2010 rate or could the tax rate go up in 2011 and 2012?
If you choose to spread over the two tax years, ’11 and ’12, the income is added to your taxable ’11 and ’12 income and the rates for each year are applicable.
The ability to defer the tax is a mixed blessing. You delay payment of course, and the time value of that money working in your favor, but you (a) run the risk of higher rates in effect
(b) an unexpected higher income – I was the beneficiary of a corporate buy out, and one year had unexpected incomes that blew our marginal bracket two levels above what I’d have planned. No sympathy, but an example of unexpected consequences.
(c) loss of ability to recharacterize if investment drops
Does an operating loss carryforward in excess of the conversion amount mean that no tax would be due on a Roth conversion???
I have too much income to contribute directly to a Roth IRA. Can I make a nondeductible contribution to a traditional IRA, and then convert that traditional IRA into a Roth IRA?
William F says
I converted my IRA to a Roth last year and wish I had left it alone. I went with the advice of friends (one whom which is an accountant) and realized my mistake at my account review with my advisor, Keith Steidle. Keith always take the time to review my accounts with me and he has given me great advice over the years so I am not sure why I didn’t run my conversion idea by him first. After discussing it with him, I wish that I had just kept the IRA as such. I suggest never doing something like this without reviewing it with a professional!