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Important Message Regarding Opportunity for Roth IRA Conversion

As 2009 has ended, a significant opportunity awaits many individuals. Beginning in 2010, taxpayers will be able to convert their traditional IRA (and funds that have been rolled over from a qualified plan) to a Roth IRA, regardless of their income level or filing status. What's more, the tax on the taxable income generated from a 2010 conversion may be deferred until 2011 and 2012. This new conversion option presents both tax planning opportunities and challenges for 2010 and beyond.

Before 2010, only individuals with modified adjusted gross incomes (AGI) of $100,000 or less could convert amounts in their traditional IRA to a Roth IRA. Moreover, married taxpayers filing separate returns have also been prohibited from converting their traditional IRA to a Roth IRA as well. However, beginning in 2010, the $100,000 AGI limit on conversions of traditional IRAs to Roth IRAs is eliminated completely. This special treatment gives everyone, regardless of his or her income level, the opportunity to convert a traditional IRA to a Roth IRA. Additionally, filing status restrictions are also lifted, allowing married taxpayers filing a separate return to convert a traditional IRA to a Roth IRA.

It is important to understand that an IRA conversion is treated as a taxable distribution, taxed as ordinary income at your marginal tax rate. This, in effect, accelerates the taxable income that you would eventually pay on distributions from a traditional IRA once you retire, but does so in exchange for never taxing any future appreciation in the value of your account from what it is today. That is often a significant tax advantage. You should also note that unlike a withdrawal from an IRA, a conversion does not trigger any 10 percent early withdrawal penalty.

Although conversion to a Roth IRA does trigger immediate taxable income, Congress provided a special incentive in 2010 to jump-start Roth conversions. In 2010 (and 2010 only), individuals will have the choice of recognizing their conversion income in 2010 or averaging it over 2011 and 2012. The latter choice allows you to pay taxes on the converted amount ratably over two years instead of recognizing it all as income in one year. You will be taxed at the rates in effect for 2011 and 2012.

For some taxpayers, their tax rate may rise after 2010 even if their income does not. President Obama has proposed a restoration of the top two pre-2001 marginal income tax rates after 2010. This means that the top two brackets could be 39.6 percent and 36 percent after 2010, or higher. Consequently, we should evaluate whether you want to elect to pay the full tax on the Roth conversion on your 2010 income tax return, at 2010 income tax rates, or on later returns at potentially higher rates.

Taxpayers are expected to convert their traditional IRAs to Roth IRAs for a variety of reasons. Roth IRAs have two major advantages over traditional IRAs:

• Roth IRA distributions are tax-free if they are qualified distributions. To be qualified, they must be made after a five-year holding period has passed and after the accountholder reaches age 59½ or on account of death, disability, or the qualified purchase of a first home.
• Roth IRAs are not subject to the required minimum distribution (RMD) rules that apply to traditional IRAs (as well as individual qualified plans). Therefore, a Roth IRA accountholder who reaches age 70½ does not need to begin taking distributions; instead, the funds can continue to grow tax free until they are needed or are passed on to heirs.

The tax-free nature of qualified Roth IRA distributions may prevent individuals from being taxed in a higher tax bracket that would otherwise apply if he or she were withdrawing taxable distributions from a traditional IRA. Moreover, these distributions - unlike those from traditional IRAs - do not effect the calculation of tax owed on Social Security payments and do not affect AGI-based deductions.

An IRA to Roth IRA conversion should be considered by individuals who:

• Can use another fund source to pay the tax on the converted amounts;
• Anticipate being in a higher tax bracket in the future or at the time of planned or required retirement distributions;
• Wish to avoid the administrative burden of annual RMD distributions;
• Are currently required to receive larger RMD's than required for living expenses;
• Have after-tax basis in their IRA, for example a non-deductible spousal IRA;
• Wish to leave beneficiaries an income-tax-free asset;

There are a significant number of tax and financial considerations that come into play when determining whether to convert your traditional IRA to a Roth IRA. If you have any questions about traditional IRA to Roth IRA conversions and the new 2010 planning opportunity, please contact your Alpern Rosenthal representative.  We have the analytical tools to provide you with the conversion scenarios you need to facilitate your conversion decision.