New 2010 Roth IRA Conversion Rules
Seven Things Investors Should Know 
Jerry Lynch, CFP^® CLU ChFC

Although Roth IRAs have been available since 1997, starting in 2010 many financial firms and companies are heavily marketing Roth IRA conversions.

 Prior to the year 2010 there were income limits to both contributing and converting to Roth IRAs. However, the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005 made some modifications to those rules starting this year. For over a decade, Roth IRAs were available only for individuals under certain income limitations. Income restrictions still exist in terms of contributions to a Roth IRA, however, recent changes have removed these restrictions for Roth IRA conversions. These changes have opened a window for investors who were previously excluded from converting to a Roth IRA to consider this conversion.

 Many financial firms are capitalizing on these new rule changes with heavy marketing, but like every important financial decisions, this decision needs to be made with extreme care and is best determined case-by-case. For an investor that already has a traditional IRA or retirement plan it is best to discuss with a financial professional whether converting to a Roth IRA is the right move before making any decisions.

 Here are seven facts that can help you weigh your decision.

1.     The income limitations for Roth IRA conversions has been removed under previous IRS laws.

Households with modified adjusted gross incomes exceeding $100,000 were not eligible for Roth IRA conversions. While restrictions still exist for contributing to a Roth IRA, there is no longer an income limit for who can covert an existing traditional IRA or employer plan to a Roth IRA.
The IRS’s removal of these income limitations has created a marketing opportunity for financial companies to promote and encourage investors to explore this option. As we mentioned earlier, this is a major financial decision and it is typically in your best interest to discuss your situation with someone who understands all of the moving parts involved.

2.     Married couples who file separately are now allowed to make Roth IRA conversions.

 Under the prior rules, married couples who filed separately were not allowed to convert to Roth IRAs (unless they have lived apart for more than one year). The new rule changes in 2010 now allow married couples who filed separately to convert to a Roth IRA.

3.     Investors who convert to a Roth IRA
in 2010 are eligible to either recognize
all the income in the year 2010 or spread the taxable income created by the conversion evenly across 2011 and 2012.

 This 2-year option of spreading out any taxable income created by a Roth IRA conversion exists only one time for those who convert their IRAs in 2010. While this may sound like an attractive feature, you need to consider what tax bracket you are in currently and whether or not you will be in more favorable tax brackets in 2011 and 2012 prior to electing this deferral. The fact that you can defer paying income taxes alone should not encourage you to convert to a Roth IRA. Like any other decision, all of the variables of your particular situation should be considered so you can make an informed decision. You should consider running the numbers for your situation to best determine the impact of making a full or partial conversion to a Roth IRA.

 4.     What is your age and time horizon.

 Should you elect to convert to a Roth IRA, there is a 10% federal penalty on any withdrawal made within the first five years from that Roth IRA. Also, like with other retirement accounts there is a 10% federal tax penalty on any withdrawal made prior to the age 59 ½ (unless an exception applies). This needs to be factored in when making your decision as to whether or not you should convert all or some of your IRA funds to a Roth IRA.

An advantage of the Roth IRA is that investors over the age of 70 ½ are not subject to Required Minimum Distributions (RMDs) and therefore those investors who do not need to use the money to live off, can continue to grow these funds tax-exempt. A qualified financial professional can help you map out, based on your age and time horizon, a strategy that is most likely to avoid or minimize the impact of penalties involved with Roth IRA conversions.

 

5.     The impact of the conversion on your current income tax rate.

 By converting to a Roth IRA you are immediately recognizing income that could propel you into a higher marginal tax bracket. Even if you elect to recognize the income as offered under the 2010 law in 2011 and 2012, you will still be recognizing income in those years which could propel you into a higher marginal tax bracket. Once again, the only way to really sort this challenge out is to crunch the numbers and try to make the best decision based upon your current tax bracket versus your future income tax bracket expectation.

 6.     Potential estate planning opportunities.

 Roth IRAs can, in certain situations, offer estate planning opportunities. For investors that have other sources of retirement income and do not need to use their traditional IRA monies during their lifetime, a conversion can help leave income tax-free Roth IRA to their heirs for gift and estate planning purposes. Because you pay the income tax on a Roth IRA up front, your heirs inherit this Roth IRA free of income taxes. When considering a Roth IRA for estate planning purposes, please keep in mind that the conversion will immediately reduce your IRA assets if you cannot pay the conversion tax with non-IRA assets and therefore you may have less money available to grow in your retirement plan. Roth IRAs offer tax-free earnings which can be more attractive than the tax-deferred earnings of a traditional IRA. However, if you have less money in your retirement account, this may not bring the results you desire.

 7.     Tax laws are always subject to change.

Remember, tax laws are always subject to change. Therefore, it is advisable for anyone making this decision and/or other decisions to stay in contact with a financial professional who is current and informed of these rules. When making financial decisions that involve tax laws it is always advisable to think about the “what ifs” and make sure you make the most informed decision.

 In conclusion, we realize the decision to convert some or all of your retirement account to a Roth IRA is complex. While this article is for informational purposes only and should not be deemed tax advice or an individualized recommendation, we hope that some of these points are helpful to you.

 Should you have any question on whether or not you should contribute or convert to a Roth IRA, we welcome the opportunity to help you map out a strategy that will be best for you situation. Saving for retirement has and always will be a priority for most investors. We enjoy helping clients and prospects explore all of their options.

 About Jerry Lynch:

Jerry Lynch is President of JFL Consulting and has over 23 years in insurance and financial planning, working with individuals in a variety of different planning areas.  He is one of the few advisors to be listed in the 2004-2010, “America’s Top Financial Planners” by Consumer Research Council of America and listed as a 5 Star Advisor in the Paladin Registry.  In addition, Jerry is a regular contributor to the Star Ledger, WABC’s Talk Radio, and CNBC. 

 If you’d like a copy of this article sent to someone else who would benefit from this information, please contact Pam Karkenny at JFL Consulting, Inc.  (973) 439-1190.  

 

This article is for informational purposes only.  This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a financial professional.

 Jerry Lynch is a Financial Planner with JFL Consulting, Inc., and also offers Securities as a

Registered Representative of Comprehensive Asset Management & Servicing Inc. – Member of FINRA/SIPC