Through 2009, you can convert a traditional IRA to
a Roth IRA only if your 2009 modified adjusted gross
income (MAGI) is no greater than $100,000 on a single
or joint tax return. The $100,000 cap will come off
in January 2010. Under current law, this change is
permanent. Therefore, high income taxpayers can convert
traditional IRAs to Roth IRAs in 2010, 2011, 2012,
and so on. For taxpayers whose 2009 MAGI is $100,000
or less, year-end 2009 presents a dilemma.
Example #1:
Wendy Ames expects her MAGI to be $80,000 this year.
She would like to invest in a Roth IRA because these
accounts may permit tax-free withdrawals in the future
and Roth IRA owners don't have to take required distributions.
Also, if she wishes, Wendy can leave her Roth IRA
intact for her beneficiaries, who will have to take
scheduled distributions but will owe no tax as long
as the account is at least five years old.
Crafting a conversion
Should Wendy convert her traditional IRA to a Roth
IRA in 2009 or wait until 2010? Although she will
owe tax on the amount she converts, in this example
her traditional IRA has a much lower value now than
it did in 2007. Therefore, a Roth IRA conversion now
would generate a lower tax obligation than it would
have created two years ago. A 2009 conversion also
will lock in this year's income tax rates, which might
be higher in the future, and start the five year clock
for tax-free withdrawals at January 1, 2009.
On the other hand, Wendy can wait a short time and
convert in 2010. Her IRA balance might be little changed
by then, and tax rates for moderate income individuals
like Wendy may not move up in the near future. If
she waits a few weeks and converts in 2010, Wendy
will have two choices: She can report the taxable
income from her 2010 Roth IRA conversion on her 2010
tax return, or she can take advantage of a special
rule for 2010 conversions and report half of the income
on her 2011 tax return and the remaining half on her
2012 return, thus obtaining a period of tax deferral.
Taking action
Some taxpayers may choose to convert by year-end 2009
because they will have a chance to reverse their conversion.
All Roth IRA conversions can be recharacterized by
October 15 of the following year; the account will
revert to a traditional IRA and the taxpayer will
get a refund of any tax paid on the conversion.
Example #2:
Tim Bradley decides to convert his $100,000 traditional
IRA to a Roth IRA in late 2009 to take advantage of
a low IRA balance and today's relatively low tax rates.
He pays the tax on $100,000 of income on his 2009
tax return. In October 2010, Tim sees that his Roth
IRA is worth $125,000. He decides to leave his Roth
IRA in place, with $25,000 of tax-free growth in the
account.
Example #3: Assume the same facts as in example #2,
except that Tim's Roth IRA has declined to $80,000
by October 2010. He recharacterizes the account to
a traditional IRA and files an amended tax return
for a refund. After waiting at least 31 days, Tim
can re-convert this traditional IRA to a Roth IRA.
If the account value has not changed materially in
the interim, Tim will owe less tax on this Roth IRA
conversion than he owed on his 2009 conversion. What's
more, if he executes the re-conversion in 2010, he
can defer the tax payments to 2011 and 2012, as explained
previously.
Be prepared
Taxpayers who expect their 2009 MAGI to be over $100,000
also may want to do some year-end IRA planning for
2010, when it will be possible to convert a traditional
IRA to a Roth IRA regardless of income. Following
are three steps you should take:
First, decide whether you want to convert your traditional
IRA to a Roth IRA. If you are concerned that the upper
income individuals and couples will pay much higher
taxes in the future, you may want to convert your
tax-deferred traditional IRA to a tax-free Roth IRA.
Second, if you would like to have a Roth IRA, decide
how much you are willing to convert. If you do a partial
conversion, you will reduce your tax obligation.
Finally, if you decide to convert your traditional
IRA to a Roth IRA, and you have determined how much
you'd like to convert, notify the custodian of your
traditional IRA in advance. There may be a rush to
convert to Roth IRAs at the beginning of the year
as many taxpayers seek to take advantage of their
IRAs' diminished values. By notifying your IRA custodian
in advance about your plans, you may be able to get
your paperwork ready for a Roth IRA conversion in
early 2010.
If you or a loved one face a similar decision, Toscano
& Ardito, PC, CPA can help you make an IRA plan
that's appropriate for your specific circumstances.
