Preparing for New IRA-to-Roth-IRA Conversion Rules

Next year brings major changes for those considering a conversion from a traditional IRA into a Roth IRA:

  • 2010 will be the first year in which taxpayers will be able to convert funds in regular IRAs (and qualified plans) to Roth IRAs regardless of their income level. Currently, only taxpayers with modified adjusted gross income of $100,000 or less may convert.
  • Unless a taxpayer elects otherwise, none of the gross income from the conversion is included in income in 2010; half of the income resulting from the conversion will be includible in gross income in 2011 and the other half in 2012.
  • Married taxpayers filing a separate return will be able to convert amounts in a traditional IRA into a Roth IRA (currently they are barred from doing so).

What to do this year?
Taxpayers who intend to take advantage of the new conversion option next year should consider the following strategies:

  1. Non-high-income taxpayers who are able to make deductible IRA contributions this year should do so. They'll reduce their 2009 tax bill and, if they make the conversion to Roth IRA next year, they won't have to pay back the tax savings until 2011 and 2012.
  2. High income taxpayers who haven't made deductible IRA contributions in the past (or made a tax-free rollover from a qualified plan to an IRA) should consider making nondeductible IRA contributions this year. The conversion generally is taxable only to the extent of earnings on the nondeductible contributions. However, if the taxpayer previously made deductible IRA contributions, or rolled over qualified plan funds to an IRA, complex rules determine the taxable amount.
  3. Some high-income taxpayers may plan to make large conversions in 2010 but plan to opt out of the deferral of tax until 2011 and 2012 because they fear they will be in a higher tax bracket in those years than in 2010. These taxpayers should avoid the standard year-end-planning wisdom of accelerating deductions and deferring income but should, rather, do the reverse in an effort to avoid being pushed into the highest brackets by a large IRA-to-Roth-IRA conversion. These taxpayers should be considering ways to defer deductions to 2010, and accelerate income from next year into 2009.


Why make an IRA-to-Roth-IRA conversion?
Roth IRAs have two major advantages over regular IRAs:

  1. Distributions from regular IRAs are taxed as ordinary income (except to the extent they represent nondeductible contributions). By contrast, Roth IRA distributions are tax-free if they are “qualified distributions.”
  2. Regular IRAs are subject to the lifetime required minimum distribution (RMD) rules that generally require minimum annual distributions to be made commencing in the year following the year in which the IRA owner attains age 70 1/2. By contrast, Roth IRAs aren't subject to the lifetime RMD rules that apply to regular IRAs (as well as individual account qualified plans).


Who should consider making an IRA-to-Roth IRA conversion?

  • Taxpayers who have a number of years before retirement;
  • Taxpayers who anticipate being taxed in a higher bracket in the future than they are now; and
  • Taxpayers who can pay the tax on the conversion from non-retirement account assets.

Please contact us if you would like to learn more about planning for an IRA-to-Roth-IRA conversion.

To comply with the requirements of IRS Circular 230, we must inform you that the information discussed above is not intended or written to be used, and cannot be used by the recipient or any other taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or to promote, market or recommend to another party any transaction, entity, investment plan, arrangement or other matter.