Fri, December 17, 2010
New Tax Law Makes 2010 Roth Conversion Taxation Choices Simpler
Now that Congress has extended lower tax rates through 2012, taxpayers should have an easier job deciding which taxation option to take for the conversion.
Starting in 2010, the tax code lifted the income limit imposed on those who wish to convert IRAs to Roth IRAs; taypayers at all income levels are now eligible to do Roth conversions.
One wrinkle in the tax law that has puzzled taxpayers is that for conversions done in 2010, you can either pay all the income tax on the conversion in 2010 or split the income from the conversion evenly over the 2011 and 2012 tax years. Tax rates were previously scheduled to increase in 2011, meaning that an income bump-up from a conversion was likely to push a taxpayer into a higher tax bracket in both years. Some taxpayers would have been better off taking the tax hit in 2010.
Of course, taking 100% of the income in 2010 might also cause a taxpayer to be moved to a higher tax bracket, but with the extension of the current brackets, taxpayers are less likely to have to pay a higher rate on conversion income that is divided between two tax years.
Taxpayers doing a Roth conversion must still “do the math” to figure out which taxation option is best, but having lower tax brackets should make the decision easier.
There are several online calculators available to help taxpayers examine the consequences of doing a Roth conversion. One of my favorites is this Roth Conversion Calculator provided by Vanguard.
If you wish to carry out a plan that hinges on spreading the conversion tax liability over two years, you’d be wise to avoid the possibility of a snag that keeps your conversion from being completed in 2010. It’s not too late to complete a conversion, but time is short. If you already have an online account with the custodian that holds your IRA, 401(k), 403(b) or 457(b) , they may allow you to do a conversion online; if not, you’ll have to mail in some paperwork. I suspect that there will be people scurrying to do Roth conversions even after Christmas, which is likely to slow the process.
Conversions that stay at the same custodian can often be completed in a day or two, but if you’re moving money from one company to another, the window of opportunity to complete a conversion in 2010 may have already closed. If there’s any doubt that funds can be transferred between different custodians in time, your best option is to do a conversion with the custodian currently holding your account and then do a transfer after the Roth conversion is complete.
As always, before making a move that has tax consequences, consult a tax adviser to be sure that you make a decision that’s appropriate for your own specific situation.