A number of tax laws enacted between 2001 and 2006 offer unprecedented reasons for investors who own Traditional IRAs to consider converting them to a Roth IRA in 2010.
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Now you’re eligible regardless of your income
Beginning in 2010, the $100,000 eligibility income cap that previously applied to individuals who converted a Traditional IRA to a Roth IRA has been lifted and investors will be free to implement a conversion regardless of income level. If you have not considered a Roth conversion in the past because your income level was too high to be eligible, you can now take advantage of it.
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In 2010 you can choose how to pay your conversion taxes
When you convert your Traditional IRA to a Roth IRA, the converted amount will be taxable at your normal income tax rate. You should consult with a tax advisor on your particular situation, but generally, the amount that is subject to taxation includes the deductible contributions you made, rollovers from qualified plans, and earnings on those amounts. However – for 2010 only – you have a choice of whether to pay all taxes due this year at one time, or to spread them over two years. If you choose to pay taxes over the two-year period, half the conversion amount will be taxed in 2011, and the remaining half will be taxed in 2012.
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Consider your expected future tax rate
Your current and future tax bracket has an impact on the long-term benefit of a Roth conversion. As a rule, if you expect that your tax bracket will be significantly lower in retirement, converting to a Roth IRA now may not be beneficial. That’s because you’ll likely end up paying more in taxes and penalties today than you would pay in retirement with your Traditional IRA. On the other hand, an expected higher federal income tax bracket in retirement would generally make it favorable to convert to a Roth IRA now.
Also keep in mind that, although subject to change by Congress, higher federal income tax rates that were in force before 2001 are set to spring back into effect beginning in 2011. Depending on your individual tax situation, this could provide more reason to implement a Roth conversion in 2010.
10% |
15% |
15% |
15% |
25% |
28% |
28% |
31% |
33% |
35% |
35% |
39.6% |
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Your time horizon makes a difference, too
The longer a Roth IRA stays open, the more time there is to make up for the taxes taken at the time of the conversion and the more time it has to grow tax free.1
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Planning ahead can help you optimize the 2010 Roth conversion opportunity. A well-thought-out plan will need to include an analysis of whether or not a Roth conversion will benefit you, as well as a review of your overall retirement, tax and estate planning objectives. A financial planner or tax advisor can help you decide.2
