As you have likely heard many times by now, changes in federal law under the Tax Increase Prevention and Reconciliation Act of 2005 (“TIPRA”) went into effect on January 1, 2010, easing the qualification limits for you to convert your traditional IRA to a Roth IRA.
There are contribution limitations and adjusted gross income levels for contributing to IRAs and Roth IRAs. If your adjusted gross income (“AGI”) is too high, you still will not be able to contribute to a Roth IRA. Specifically, the $5,000 permitted contribution to a Roth IRA is reduced ratably if your AGI is between $105,000 and $120,000 for single, head of household, or married filing separate and you did not live with your spouse during 2010 taxpayers (same as 2009), between $167,000 and $177,000 for married filing jointly or qualifying widow(er) taxpayers (up $1,000 from 2009), and between $0.00 and $10,000 for married filing separate and you did live with your spouse during 2010 taxpayers (same as 2009). But we are not going to talk about that any more. We will talk about the Roth IRA conversion.
TIPRA determines if you can convert all or part of your traditional IRA (or other qualified retirement plan) to a Roth IRA based upon your Modified Adjusted Gross Income (“MAGI”). Prior to 2010, you could only convert to a Roth IRA if your MAGI was under $100,000. Beginning in 2010 and after, however, that MAGI $100,000 limitation is entirely eliminated.
The concept of MAGI may confuse you, as it has for many other people from the very start. After you determine your AGI from your 1040 return, you then figure MAGI by adding back certain items like the foreign earned income exclusion, deductions for foreign housing, interest income for series EE bonds that you excluded because you used the proceeds to pay for qualified educational expenses, deductions that you may have claimed for student loan interest or allowable tuition expenses, etc.
Two other items are important to keep in mind for this calculation. Required distributions from your traditional IRA after you reach age 70½ do not count against the MAGI. Also, funds converted from a traditional IRA to a Roth IRA do not count against your MAGI even though they may be taxable. There are more intricacies to this MAGI calculation, but this brief description should help.
The expanded opportunity to convert to a Roth IRA is one of the few “silver linings” during the current pervasive economic downturn we’ve been experiencing. Since you will have to pay ordinary income tax at your tax rate on the amount converted from traditional to Roth IRA, what better time to do so than when the balance is at a low point. One other feature of the law that went into effect in January 2010 is that the taxation of the balance you convert to a Roth IRA during 2010 can be deferred into tax years 2011 and 2012.
The benefits of converting to a Roth IRA or not, should be obvious after appropriate financial counselling. There are no required minimum distributions after age 70½, growth in the Roth IRA is tax deferred, distributions from a qualified Roth IRA are tax free, you can still contribute to a Roth IRA after age 70½ (unlike a traditional IRA), contributions are made with after tax dollars, etc.
There are, however, cons or downsides to be considered when you convert to a Roth IRA, and your learning, study, and counselling on this subject should take this into consideration.
Finally, it sometimes makes sense for you as a Roth IRA owner to convert your Roth IRA back into a traditional IRA, perhaps due to a greater income tax liability than anticipated or other realities. This “recharacterization” allows you to “undo” up to your entire current year Roth IRA conversion. You must recharacterize your Roth IRA by October 15th, the extended filing date of your current year income tax.
Once again, there is more detail to be mastered here in the recharacterization world from Roth to traditional or vice versa, including “anti-cherry picking rules” put in place by the IRS. Make sure you get proper counselling from a trusted financial advisor to make the best informed decision for you and your family.
By: Matthew M. Wallace, CPS, JD
Published edited June 6, 2010 in The Times Herald newspaper, Port Huron, Michigan as: How to convert traditional IRAs to Roth IRAs