Roth IRA Conversion: Good Timing is Important

By Humberto Cruz

My wife, Georgina, and I don't have a 2010 calendar, so we've made this entry for Dec. 31, 2009:

"On Jan. 2, 2010, convert a chunk of our traditional IRAs to Roth IRAs."

This move will make a lot of sense for us - and for many other people, I believe.

"The Roth IRA conversion will be a big issue for people going forward, especially when 2010 hits and everyone qualifies for a conversion," said Ed Slott, a certified public accountant in Rockville Centre, N.Y., and nationally recognized expert on IRAs.

When you convert a traditional IRA to a Roth, you owe tax on the converted amount as if you had simply withdrawn it from the traditional IRA (which in fact you have). But a conversion avoids the normal 10 percent penalty on IRA withdrawals before age 59-and-a-half. Once in the Roth IRA, the converted money can grow not just tax-deferred but completely tax-free, and without the mandatory withdrawals after age 70-and-a-half that traditional IRAs impose.

A key point to keep in mind is that the tax you owe when you convert does not depend solely on the amount converted. Rather, you pay tax based on your total taxable income for the year, including any converted amounts.

Also, you may convert all or just part of a traditional IRA. Therefore, you may be able to convert just enough each year to keep within your tax bracket.

For 2009, you are not allowed to do a Roth conversion if your modified adjusted gross income - whether single or filing jointly, and not counting the converted amount - exceeds $100,000.

But beginning in 2010, anybody can convert regardless of income. And for 2010 only, the converted amount does not have to be declared as income for 2010. If you choose, you may report half the converted amount as income for 2011 and the other half for 2012.

Therefore, you can make a conversion on Jan. 2, 2010 and not have to finish paying taxes on it until April 15, 2013, the deadline for the 2012 tax return. By spreading the conversion income over two years, you also lower the odds of a conversion pushing you into a much higher tax bracket.

This works perfectly for us because Georgina and I anticipate our other income will decline in 2011 and 2012 as we phase down our work and cash in maturing interest-paying investments. We may be able to convert a fair amount in 2010 and still keep within the 15 percent tax bracket in 2011 and 2012 (the ceiling of the 15 percent bracket, adjusted annually for inflation, is $67,900 of taxable income for joint filers in 2009).

Even if a conversion pushes you into a higher bracket for a year or two, it's worth considering if you think you would have paid higher taxes on future traditional IRA withdrawals. That could happen either because mandatory withdrawals after 70-and-a-half push you into a higher bracket or simply because tax rates go up.

"It is likely that income tax rates will increase in future years, making tax-free Roth IRA income more valuable," Slott said. (Roth IRA withdrawals are completely tax-free and penalty-free once we reach 59 and a half and contributions and any converted amounts have been in the Roth IRA five years). Even if the rules are changed in the future to make Roth IRAs less attractive, existing accounts will likely be "grandfathered" under current rules, judging the way Congress has acted in the past, Slott said.

Investing - Roth IRA Conversion: Good Timing is Important

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