Conversion to Roth in 2010: WSJ article
Part of WSJournal's Encore section, which deals with retirement investing issues. FYI only:
Going Roth in 2010 Still Holds a Potential Catch
March 1, 2008 WSJournal, Kelly Greene, columnist
Q: If your income limit is too high to contribute to a Roth IRA, would it make sense to contribute to a non-deductible traditional IRA? My understanding is that in 2010, traditional IRAs can be converted into Roth IRAs, regardless of your income, as long as you pay the taxes on any earnings in the account at that time.
It seems like a good idea, as it allows us to make contributions for several years, pay a relatively small amount of tax on any earnings (since the base deposits were already taxed), and then have the benefits of a larger Roth account growing tax-free. Are there any hitches?
--Mary Smith Thornton, Colo.
A: Last week, we dealt with readers who earn too much money to contribute to Roth IRAs, from which retirement withdrawals are generally tax-free. They asked if it's worth making such contributions anyway and paying the penalties involved; we replied that the penalties could continue for many years, and the Internal Revenue Service could wind up disqualifying their accounts anyway.
This week, we turn to a legal strategy for accomplishing the same goal: getting more assets into a Roth individual retirement account. Under tax rules, you can convert a traditional IRA to a Roth only if your "modified adjusted gross income" is no more than $100,000 a year. (You can figure out your modified adjusted gross income using a worksheet on page 61 of Publication 590 at www.irs.gov.)
However, starting in 2010, there's no income limit for converting traditional IRA assets to a Roth. And for 2010 conversions, you get to spread your tax payments over two years. "If you converted $80,000 in 2010, you'd pay tax on $40,000 in 2011 and pay tax on $40,000 in 2012," says Ed Slott, a Rockville Centre, N.Y., IRA consultant. "In some cases, you wouldn't be done paying taxes until you file your return for 2012 in 2013. So the government has, in effect, given everyone an interest-free loan to build a tax-free savings account."
One potential catch: "Who knows what tax rates will be in 2011 and 2012?" Mr. Slott says. "If you qualify to convert now, you should take advantage of tax rates that are probably the lowest that we'll see in our lifetime."
Of course, if you can't swing the taxes now, or all at once, you could also convert small chunks of IRA assets over many years to minimize the tax bite.
Keep in mind that if you convert your traditional IRA to a Roth, you don't have to pay tax again on any nondeductible contributions that you have made in the past to that traditional IRA. But you can't cherry-pick the assets you wish to convert: The government considers any amount you convert to come proportionately from after-tax contributions, pretax contributions and any earnings. Let's say your traditional IRAs have a combined value of $100,000, including $10,000 in nondeductible contributions. If you convert $10,000 to a Roth, 10% of that amount, or $1,000, would be tax-free, because 10% of the total value of the IRA already had been taxed.