Roth Part II - To Convert to a Roth or not to Convert – The Answer is Maybe

The Roth IRA has been around for more than a decade, so why have you been hearing so much about it over the last year? Before 2010, taxpayers with AGI, or Adjusted Gross Income, over $100,000 were not allowed to convert or to roll over funds from traditional (deductible or non-deductible) IRA accounts or certain employer-sponsored retirement plans (ex. 401(k) plans) to a Roth account. For 2010 and later, taxpayers of all income levels and filing statuses can convert to a Roth account.

Traditional, deductible IRA accounts and employer-sponsored retirement plans allowed people to exclude their contributions when figuring their taxable income. That is one of the beauties of the traditional IRA and other retirement plans – do not pay tax on the money now, but pay the tax on the withdrawals years later.

So what happens when you convert to a Roth IRA? When the money is converted to a Roth IRA account, income tax is paid on the funds in the year of the conversion. How much tax you pay in the year of conversion is a complex formula based on your tax rate and the value of your IRA accounts at the time of conversion. Only for 2010, the income from the conversion will not be recognized in 2010, but half will be recognized in 2011 and half will be recognized in 2012.

So if you report the converted amount as income and pay income tax, why would you convert? Isn’t better to wait and pay the tax when you withdraw the money from the account? The decision to convert boils down to several questions:
1. do you have the money to pay the tax now from accounts other than the IRA;
2. what do you plan to do with the money in the future;
3. how long do you have until retirement; and
4. what do you think the tax rates will be when you retire.

There is no right answer. In fact, there are several professional software programs designed to help your tax adviser walk through the possibilities to see if a conversion is right for you.

What if you decide you do not want to convert after the paperwork is signed? You can take advantage of the "free look" provisions in the law. These rules allow you to reverse or "recharacterize" your Roth converted amounts back to a traditional IRA. However, the recharacterization must be done by the time you file your tax return, including the extension period.

With concerns about the overall economy, sluggish investment returns, lower retirement account values and potential future increases in tax rates, the time could be right to recognize income today with the thought of finding tax savings in the future.

--- Donna Boyette, CPA, Senior Staff Accountant