Back in May of 2006 there was a pretty significant change to the tax laws involving converting a traditional IRA to a Roth IRA. In the year 2010 everyone can convert their traditional IRAs to a Roth IRA - and that's an opportunity that not everyone had in the past. In this article we're going to talk about the Roth IRA conversion rule change that goes into effect in 2010. We're also run through some of the strategies that individuals can use to take advantage of this change, starting today.
Roth IRA Conversion Rules
Under the current tax law for Roth IRA conversions - which was written in 1997 - individuals were permitted to convert a traditional IRA to a Roth IRA. There were only two stipulations that taxpayers had to worry about - paying taxes on the converted money and an income limit which determined eligibility to convert.
Converting an IRA to a Roth With a traditional IRA money can be placed into the account on a pre-tax (tax deductible) and after-tax basis. That investment is allowed to grow on a tax-deferred basis until withdrawn in retirement.
If an individual wanted to convert a traditional IRA to a Roth IRA they had to pay federal income taxes on any pre-tax contributions as well as any growth in the investment's value. After all, once converted to a Roth, all of the investment could now be withdrawn on a tax-free basis in retirement.
Income Limits on Conversions Unfortunately, that same 1997 tax law also contained a provision limiting who could make a conversion. Upper income taxpayers - those with adjusted gross incomes of more than $100,000 - whether single or married were not eligible to make such a conversion.
In addition, if you earned $110,000 or more ($160,000 for married joint filers) then you also weren't eligible to contribute to a Roth IRA. These two tax laws effectively precluded upper income taxpayers from enjoying the benefits of a Roth IRA. They couldn't convert their traditional IRA to a Roth, and they could fund one either.
IRA Conversions in 2010 But back in May of 2006 President Bush signed a $70 billion tax cut provision that changed the eligibility rules for Roth IRA conversions. Starting in 2010, taxpayers with modified adjusted gross income of more than $100,000 will be allowed to convert a traditional IRA to a Roth IRA. This change applies to all years beyond 2010 - and the income taxes due on the 2010 conversion can be spread over two years. So the 2010 conversion amount may be included as taxable income in 2011 and 2012 - helping to spread out the tax bite. Conversions in subsequent years are included in income during the tax year in which the conversion is completed.
Removing the Roth IRA conversion cap however doesn't mean anyone can fund a Roth IRA, but it does mean that anyone can convert an existing IRA to a Roth IRA.
Taking Advantage of the 2010 Rule Fortunately there is a way for all taxpayers - regardless of income - to take advantage of this change in the tax code:
Start Funding a Traditional IRA Right Now!
Even if you don't qualify to make Roth IRA contributions or traditional IRA contributions on a before-tax basis, you can still make after-tax contributions to a traditional IRA. If you invest in a non-deductible IRA in the tax years 2006 through 2010, then you can convert those IRAs to Roth IRAs in 2010.
Most investors shy away from making non-deductible contributions to an IRA because they are not tax deductible, the investment growth is fully taxable, and because they are subject to minimum distribution rules they offer only a minimal tax shelter. But by converting these non-deductible IRAs to Roth IRAs in 2010 many of those disadvantages disappear.
Roth IRA Conversion Examples There is one important rule to keep in mind when it comes to converting a traditional IRA to a Roth IRA - you need to pay federal income taxes on any portion of the conversion that you haven't already paid taxes on.
Example 1 For example, let's say you started to fund traditional IRAs in 2006 and by 2010 you've got $20,000 in your account. Furthermore, let's say this account consisted of four years of $4,000 non-deductible contributions - a total of $16,000 in non-deductible contributions and $4,000 in account growth.
In this example, you'd need to pay income taxes on the $4,000 in fund growth when you convert to a Roth IRA. But the good news is you'll never have to pay income taxes on this account again.
Example 2 In this second example, let's assume that you funded the that same traditional IRA with before-tax dollars - meaning you were able to take a deduction on your tax return for the money placed in the traditional IRA.
In this example, you haven't paid income taxes on any of the money in the account, so when you convert it to a Roth IRA taxes are owed on the entire account balance. In this case you'd have to pay income taxes on all $20,000 in your fund.
Example 3 If you have an existing traditional IRA (with tax-deductible contributions) and you start to fund a non-deductible IRA, then you need to be aware that tax rules state that any conversion is done on a pro-rata basis. Let's say you had $100,000 in a regular IRA and you had $25,000 in a non-deductible IRA.
If you wanted to convert $25,000 to a Roth, then you'd owe taxes on $20,000 because the pro-rata share of your non-deductible contributions is only $5,000.
Deciding to Fund a Roth IRA While it might be very exciting for some individuals to learn that they can use this 2010 law to convert an IRA to a Roth IRA, it's important to mention that Roth IRAs are not for everyone. Before converting you might want to read our article dedicated to explaining the differences between a Roth IRA and a Traditional IRA. You might also want to run through some what-if scenarios using our Roth versus Traditional IRA calculator.
It's always best to make an informed decision and if you ever have a question about what's right in your particular situation it might be a good idea to consult with a tax professional before deciding if taking advantage of the rule change in 2010 is right for you.
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发表于 2009-10-17 20:22:54
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发表于 2009-10-20 23:13:35
