ROTH IRA CONVERSION OPPORTUNITY

Beginning January 1, 2010, all taxpayers will be eligible to convert their traditional IRA to a ROTH IRA. This conversion will allow future tax free distributions during retirement but the conversion itself is taxable. So you would be paying tax now to obtain future tax free withdrawals and be exempt from the required minimum distributions which apply to regular IRA’s. In the correct circumstances, a conversion can save substantial income taxes in the long run and create wealth for your heirs. The decision to convert requires careful consideration because converting is not always favorable.

Good candidates for conversion

If you meet the following criteria, a conversion may be favorable.

1. You can pay the tax owed at time of conversion from funds outside of the IRA.
2. You do not expect a significant decline in your tax rates during retirement.
3. You can make the conversion at a younger age.
4. You do not expect to begin drawing from your IRA until later in retirement
5. You expect to leave a significant portion of your IRA to your heirs.

Calculating the tax owed upon conversion

The conversion income is taxed at ordinary tax rates. So if you are in the 28% marginal rate and you have $100,000 income upon conversion, you will owe $28,000 Federal income tax plus state income tax. Special rules allow taxpayers converting in 2010 to split this income in half between 2011 and 2012. For conversions made in 2011 or later years, the tax is payable in the year of conversion. If your existing IRA has been funded with tax deductible contributions, then the value of the IRA at the date of conversion is reported as income. If your existing IRA has been partially funded by non deductible contributions, then the portion related to the non deductible contributions is tax free.

Partial conversions are available

You do not have to convert your entire IRA. You are allowed to convert any portion of your IRA. This should be helpful since most taxpayers will not have sufficient funds to pay the tax if they convert their entire IRA.

 Rescind the conversion

You are allowed to “recharacterize” the conversion up to the due date (including extensions) of the tax return. Therefore, you have the ability to rescind a 2010 conversion up to October 17, 2011. This would be desirable if the value of your IRA declines subsequent to the date you converted.

Make an informed decision

Please contact us if you would like to arrange a consultation on this subject. We have developed a template to assist in making calculations to determine if a conversion is favorable. This decision should be made in the context of your overall financial situation.

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IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, except as may be expressly stated herein to the contrary, any U.S federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding penalties under the Internal Revenue Code or (b) promoting, marketing or recommending to another party any transaction or matter addressed herein.