Q: What does a carton of milk and a 2010 Roth IRA conversion have in common? 
A: They both have important expiration dates.
For investors who convert any portion of their Traditional IRA to a Roth IRA in 2010, they will have the option to defer paying the taxes into future years. This is a one-time offer that expires December 31st, 2010.
A new rule that is not expiring is the removal of the income limit to be eligible to convert to a Roth. This means from now on, anyone is eligible to convert their Traditional IRA to a Roth IRA without regard to their level of income. The difference will be that after 2010 the taxes on the conversion will be due in the tax year that the conversion is made and cannot be deferred to future years.
The IRS is allowing taxpayers a one-time opportunity to defer the payment of taxes due on a 2010 Roth conversion over two future tax years, 2011 and 2012. This means the tax deadline for 2010 Roth conversions can be pushed out to 50% on April 15, 2012 and 50% on April 15, 2013. If you do a 2010 Roth conversion, you have until October 15, 2011 to change your mind, put the money back in your Traditional IRA, and owe no taxes.
A Roth conversion is simply taking part or all of your traditional IRA and changing it to a Roth. Since the traditional IRA is usually pretax money, the IRS wants its taxes when you convert. The good news is that you are done with taxes for that chunk of money since all qualified distributions from Roth IRAs are tax-free.
The decision to convert simply comes down to deciding to pay the taxes now or pay the taxes when you withdraw the funds at a later date.
Simple Math suggests that:
- You are better off converting now if you think your tax bracket will be higher in retirement.
Arguments for converting
- You expect tax rates to be going way up...who doesn't?
- You expect high income upon retirement...problem most people would like to have!
- You are in a low tax bracket today... conversion merits serious consideration.
Arguments for staying put
- There is no outside cash to pay the taxes due.
- You expect to have low taxable income during retirement.
- You are in a high tax bracket today.
Most common advice - Consider partial conversions over time to provide some tax diversification in retirement because most investors have more money in Traditional IRAs than Roth IRAs. Or better yet, call us to perform a "Roth Conversion Analysis" for your specific situation. Do not wait until New Years Eve!
