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Home » IRA's, Retirement Planning, Roth IRA, Taxes

2010 Roth IRA Conversion Rules: What’s the Big Deal About 2010?

Last updated by on 5 Comments

2010 Roth IRA Conversions: Why this Year is Special

Roth IRA conversions in 2010 are of special significance due to some unique tax circumstances and rule changes. If you’ve considered making a Roth IRA conversion from a traditional IRA and have worried about the tax implications, or haven’t been able to contribute to a Roth in year’s past due to high income levels, you’ll want to pay close attention.

There is one big tax rule related to conversions that only takes place in 2010 and others that are new this year that make it a special year for a conversion. Before getting into why 2010 is so significant, let’s first cover what a Roth IRA conversion is and why you might want to consider it in the first place.

What is a Roth IRA Conversion?

A Roth IRA conversion is actually a rollover from a Traditional IRA to a post-tax Roth IRA. Roth IRA’s are an attractive investment vehicle because all earnings are tax-free upon withdrawal in retirement. Many big proponents of Roth IRA’s advocate for them because they think tax rates will increase in future years and if you expect your tax bracket in retirement will be higher than it is now it might also make good sense to convert, because you don’t have to pay future taxes in retirement on Roth IRA’s.

The Drawback: Tax Liability Now

The drawback to converting from a Traditional IRA to a Roth IRA is that you must pay taxes on the conversion amount, when you make the conversion. You’re taxed at whatever your tax rate is for that year. Because you didn’t pay taxes up front with the Traditional IRA, you pay taxes on the amount going to your Roth (which you would have done in the first place had you originally contributed to your Roth).

If you don’t have significant savings on hand immediately, this can be a huge impeding factor that might cause you to shy away from a conversion altogether. It’s usually wise to save ahead of time so that you have enough cash on hand to pay for the conversion taxes. Now, let’s get in to why 2010 is a big year for Roth conversions.

2010 roth ira conversion

The Three Big Roth IRA Conversion Changes in 2010

1. Roth IRA Conversion Income Limit Restrictions Removed

Prior to 2010, you could not convert from a traditional IRA to a Roth IRA if your modified gross adjusted income (magi) exceeded $100,000. In 2010 (and beyond), that rule has been eliminated.

2. High Income Earners Can Now Avoid the Roth IRA Income Limits

Roth IRA contributions have income phaseout limits. This prevents high wage earners from being able to contribute to Roth IRA’s. However, those same high earners with traditional IRA’s can now get into Roth IRA’s through the backdoor via the aforementioned $100,000 conversion income limit restriction being removed.

These converters, however, will not be able to contribute new funds directly to a Roth IRA. They’ll have to move funds over via a conversion in any year that they want to put funds into a Roth IRA.

3. Spread Out your Tax Liability Over 2011 and 2012

Unique only to 2010 conversions, you are able to choose between paying taxes on your converted dollars on your 2010 tax return, or spread out the payment in 2011 and 2012 (50% on each year’s tax return). This way, if you don’t have the savings immediately at hand or don’t want to deplete  your emergency savings, you can spread out the tax liability to 2011 and 2012. In other years (including starting again in 2011), you have to claim the conversion amount as ordinary income for that tax year.

Note that it is recommended that you pay the tax liability with saved non-retirement dollars versus pulling funds from your IRA, which kind of defeats the point of the conversion in the first place.

Things to Note on IRA Conversions:

  • Carefully consider this move before you make it. If you’re thinking about making a conversion, it is one of those times that it might pay off to speak with a CPA, CFP, or other certified professional. There may be a number of situations where making a conversion does not make good financial sense.
  • The conversion rules also apply to employer plans such as 401k’s.
  • The conversion itself shouldn’t cost anything, minus a few trading or account closing fees. Excluding the taxes, of course. Any discount broker, such as TradeKing (note: TradeKing does not charge annual fees).

Roth Conversion Discussion:

  • Have you (or will you) make the Roth IRA conversion this year? Why or why not?
  • If you are making the conversion, are you spreading it out over 2011 and 2012?

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5 Comments »
  • I think the Roth IRA is a better deal. The real reason behind this conversion mania is the govt. needs the additional revenue. It wants to get paid now rather than later. If your starting to invest or otherwise go with the Roth.

  • Jay says:

    I still don’t understand why anyone would convert to Roth unless not paying tax at all.
    Here is an example of converting 100K Traditional IRA
    to Roth IRA at 10% tax bracket,
    assuming 8% annual return for 10 years:

    Amount Amount Tax Total Final
    after after rate Tax in-hand
    tax: 10yrs amount
    Trad. 100K -> 215K 10% = 21K => 194K
    Roth 90K -> 194K 10% = 19K => 175K

    Clearly even at 10%, one is better of keeping in traditional and pay as it is withdrawn later.
    Am I missing something?

  • IRA says:

    Jay,
    yes, there is a major flaw in your argument. You’ve taken out the taxes on the Roth twice. If you pay it once on the conversion date, then you do not pay the taxes again when you take the money out. In your example, the money at retirement is the same if you assume that the money is pulled completely pulled out at retirement.

    In both cases you end up with $194k.

    I believe that the traditional IRA has a required minimum distribution that you must pull a certain amount of money each year (and pay taxes on it as ordinary income). If you end up not needing the money, this might be kind of annoying. The roth IRA might give you a bit more freedom in deciding what to do with your money, since the gov’t no longer has any claim on the taxes.

    If you feel that you will be in a lower tax bracket when you retire, then you may wish keep the traditional IRA. If you’ll be in a higher tax bracket when you retire, you would be better off in a Roth.

    If tax brackets don’t change, then you might be indifferent, but the RMD would probably make me want to favor the Roth.

  • Jay says:

    Thanks IRA. I got the missing link.
    So if I remove the 2nd tax from Roth, it is:
    tax: 10yrs amount
    Trad. 100K -> 466K 10% = 46K => 420K
    Roth 90K -> 419K no tax => 419K
    So practically there is no difference but if I am in lower bracket than it will be worth as Traditional.
    Also if you are in higher bracket now than it doesn’t make any sense to convert it either.
    Thanks.

  • Dave says:

    If I have 7 different IRA Accounts at several banks, can I pick and choose which IRA’s to convert? If I converted all 7 and decide to reclass 3 back to traditional IRA’s before April 15th, 2011, can I reclass just 3 and leave the other 4 as conversions. I have 4 IRA’s that have really gone up in value that I want to keep as Roths, but 3 are down in value and it makes more sense to reclass them back to traditional IRA’s. I just want to make sure that is legal to do.

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