2010 Roth Conversion Rules

Today we’re covering the 2010 Roth conversion rules in the second of a series on Roth IRA conversions.

As mentioned yesterday in How to Make a Roth IRA Conversion, some special rules went into effect on January 1 that make 2010 Roth IRA conversions more attractive than ever.

If you haven’t yet, you should really consider converting to a Roth IRA this year. This is especially true if you do not qualify to contribute to a Roth IRA and have been unable to reap its benefits.

2010 Roth Conversion Rules

Rules specific to 2010 roth conversions include the following:

• No income limits: For the first time ever, all taxpayers can rollover a traditional IRA to a Roth IRA, regardless of income. So if you’ve had too high of an income to contribute to a Roth, and took advantage of a deductible or non-deductible traditional IRA instead, you can convert all contributions plus growth to a Roth – paying taxes on the converted amount but then enjoying tax-free growth forever. As of now, this provision is permanent.
• Extension of tax payment: Ordinarily, taxes are due on all IRA account growth as well as any deductible contributions. In 2010, you can actually defer paying taxes on the converted amount by completing the conversion in 2010 but claiming half the income in 2011 and half in 2012 – meaning half of the actual tax payment could be deferred to spring of 2013! You can also elect to pay all taxes in 2010. Be aware that you will pay taxes at your rates in those years, so you should pay now if you expect your personal bracket to increase. Spouses can make different elections, but each taxpayer has to apply the same election to all accounts – you can’t choose to pay taxes on one IRA but defer them on another. This election is special for 2010 and will expire in 2011.  

Other Roth Conversion Rules

Other than the two mentioned above, Roth conversion rules remain the same. So remember:

• Contribution limits remain the same. 2010 Roth IRA limits haven’t changed. If you are over the income limits for Roth IRA contributions, you cannot contribute new funds to a Roth. However, as long as the special 2010 roth conversion rule above exists, you can contribute to a traditional IRA and immediately convert.
• Pro-rata rules apply. If you do choose to go the conversion route, you don’t have to convert all your funds. One reason to do it in pieces is to spread your tax bill over many years. However, if you have made both deductible and nondeductible IRA contributions, any partial conversion will be deemed to come from both pools, in a ratio equal to your original contributions. What this means is, you can’t avoid taxes by choosing to convert only nondeductible contributions. However, if you’re willing to put in some work, there is a Roth conversion workaround strategy.
• Regardless of the timing, taxes will be due. At some point, you will owe taxes on your Roth conversion, whether you choose to defer them or not. You should only convert if you can afford to shoulder the tax bill with non-retirement funds. If you use part of the converted amount to pay taxes, you miss out on the compounding growth and may face an early withdrawal penalty.

Check back tomorrow to find out Should You Do a Roth Conversion?

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