Health Care Reform and Roth Conversions: Know the Tax Rules

Kimberly Lankford

Kiplinger Personal Finance

Q: Will health-care reform affect Medicare beneficiaries who convert their traditional IRAs to a Roth?

A: It certainly will. Medicare beneficiaries always have to be careful about Roth conversions because the money you convert increases your taxable income for the year. That could cause you to pay a high-income surcharge for Medicare Part B, which currently applies to people whose adjusted gross income in 2008 (the most-recent tax return the IRS has on file) was more than $85,000 (or $170,000 on a joint return). Most people who earned less than that threshold pay $96.40 per month per person for Medicare Part B in 2010. But people who earned more than that must pay $154.70 per month or more (the charge maxes out at $353 per month for the highest-income people).

The new health-care-reform law freezes the high-income surcharge limit at $85,000 for single filers ($170,000 on a joint return) from 2011 to 2019, rather than increasing the income cut-offs with inflation. And, most important, it imposes a high-income surcharge on Medicare Part D premiums for people with adjusted gross incomes above the $85,000/$170,000 level.

You can generally contest a high-income surcharge if you have a life-changing event, such as marriage, divorce, job loss or reduced work hours (including retirement), that affects your income level. But converting a traditional IRA to a Roth doesn't count.

If your IRA conversion gets you close to the $85,000 or $170,000 limit, be aware of the surcharge when deciding whether it's worthwhile to convert, when the conversion might work best, and whether it helps to pay taxes on a 2010 conversion with your 2011 and 2012 returns.

But it's also important to keep a Roth conversion's impact on Medicare premiums in perspective when you make your decision.

"If no Roth conversion occurred, the taxpayer would have to start taking required minimum distributions from a traditional IRA at age 70 ½, which could also increase Medicare premiums, only over a longer period of time," says Mark Luscombe, principal analyst with CCH, a provider of tax information. "One would have to do a careful analysis, therefore, to determine whether the proposed Roth conversion over the long term was harmful or beneficial to Medicare premiums."

Personal Finance - Health Care Reform and Roth Conversions: Know the Tax Rules