Eight months and counting. Effective January 1, 2010, the income limitation preventing people from converting their IRAs and other qualified retirement accounts to a Roth IRA disappears.
What makes Roth accounts so attractive? "While you don't get a current year tax deduction for money contributed into a Roth, any money invested within your Roth grows tax-free. As long as the rules don't change down the road, you'll be able to withdraw money from your Roth upon reaching age 59 1/2, and you won't pay even a dime in taxes on the money withdrawn," explains Andrew Schwartz CPA, founder of FindAGoodCPA.com (www.FindAGoodCPA.com), a site where taxpayers can locate a tax professional in their metropolitan area based on the professional's specialty
Even though Roth IRAs were first introduced back in 1998, many middle-income and high-income taxpayers have never had the opportunity to contribute money into these tax-free retirement savings accounts. For 2008, single individuals who earned more than $116k and married couples who earned more than $169k were ineligible.
A second way to get money into a Roth IRA has been even more restrictive. Since the Roth rules were first instituted eleven years ago, the income threshold to be able to convert your existing IRAs or other qualified retirement accounts to a Roth has been stuck at $100k . Please note that the same $100k threshold applies to single individuals and to married couples. (Talk about the marriage penalty.)
One relatively new option available to many taxpayers looking to get some money into a Roth account is to take advantage of the Roth version of an employer sponsored 401(k) or 403(b) Plan. "I am not generally a big fan of this strategy for people in the higher tax brackets. Remember, you are giving up a valuable current year tax break in exchange for a promise from the government that they won't change the rules between today and when you retire. I don't trust those guys in Washington to keep their word," warns Schwartz.
"Fortunately, there is a more tax efficient strategy available to you to finally get some money into a Roth IRA. You don't give up a current year tax break when you make non-deductible IRA contributions that you subsequently convert to a Roth IRA in 2010. Depending on what your IRAs are worth versus the non-deductible contributions you made over the years, you could conceivably end up owing no income taxes on the money you convert. And even if you do have income to report, the rules allow you to spread the income from the 2010 Roth conversion over two tax years."
What steps should you take now in anticipation of converting your IRAs and other eligible retirement accounts to a Roth IRA in 2010?
Check Your Balances
The first step is to see how much you have in your IRA accounts. Yes, even though the Dow is still way down from it's peak of $14,000, start by doing the unthinkable and opening your statements to tally up the value of all of your IRA accounts. Don't forget to include all of your traditional IRAs, rollover IRAs, SEP IRAs, and SIMPLE IRA accounts.
Verify Your Non-Deductible Contributions
Next, figure out the total of your non-deductible contributions you've made over the years. The easiest place to find this number is to pull out your 2008 Form 1040, and take a look at the Form 8606 attached. This is the IRS tax form used to keep track of your cumulative post-tax IRA contributions.
Don't despair if you haven't submitted a Form 8606 each year or the number reflected on the current year's 8606 is incorrect. The IRS allows you to file this form as a stand alone form. Simply enter the correct totals for the non-deductible contributions made through 2008, sign the form on the bottom of page 2, and submit the signed Form 8606 to the Internal Revenue Service where you would otherwise file your Form 1040. It's very important that the IRS have the correct info on file in anticipation of your converting your IRAs to a Roth IRA in 2010.
Figure the Tax Burden
Here is where things might get a little tricky. Does it make sense for you to convert your IRAs to a Roth IRA?
If the value of all of your IRA accounts is less than the total of your non-deductible contributions as reflected on your 8606, there is no reason not to convert to a Roth in 2010. As an added bonus, you can even claim your remaining IRA basis as a miscellaneous itemized deduction provided you convert 100% of your IRAs by the end of the year.
What if your IRAs are worth more than your after-tax contributions? Expect to pay taxes on the percentage of each dollar converted that represents the pre-tax portion of all of your IRAs.
For example, let's say your IRAs are worth $60,000, and you made a total of $20,000 of non-deductible contributions over the years. In this example, there would be $40,000 of pre-tax dollars built into the $60,000 of IRA value, which means two-thirds of each dollar converted would be taxed.
Basically, the smaller the percentage of post-tax dollars within your IRAs, the tougher this decision becomes. And remember, if you have multiple IRA accounts, you need to determine the pre-tax amounts included within all of those accounts - even if you only ever made your non-deductible contributions into just one IRA account.
We Can Help
Need help figuring out what to do about this rapidly approaching opportunity? For starters, work through the 2010 version of our Roth Conversion Quiz which you can find at http://www.findagoodcpa.com/2009news/news0509.php.
Still need help? "Please contact the nearest CPA or EA listed on our directories at www.FindAGoodCPA.com to help you work through the math and make a prudent decision," suggests Schwartz.
About Andrew D. Schwartz CPA
Andrew D. Schwartz, CPA is the editor and founder of www.FindAGoodCPA.com, a site where taxpayers can interact with CPAs who specialize in a variety of niches such as healthcare, real estate professionals, and lawyers. Schwartz has provided tax and basic financial planning advice in interviews with various media, including the Washington Post and Wall Street Journal. He is available for interviews.
