500 Newport Center Drive, Suite 500
Newport Beach, CA 92660
Phone: (949) 721-2330
Fax: (949) 721-0734
February 2009 
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Roth IRA Conversion
By Marty McNamara, CPA, CFP®
As we head into the last quarter of 2009, it's time to gear-up for year-end tax planning. And because tax planning is most valuable when multiple tax years are considered, we are already planning for a one-time change in the 2010 tax law that allows for an additional strategy for high income taxpayers.
The strategy is called a Roth IRA conversion and it's been around since the 90s, but tax law has limited the strategy to those with AGI under $100,000. In 2010, the $100,000 AGI limit will be lifted and anyone can convert a traditional IRA to a Roth IRA.
There are two primary advantages a Roth IRA has over a traditional IRA:
(1) Distributions from a Roth IRA are can be taken tax-free, unlike traditional IRA distributions which are subject to ordinary income taxes.
(2) Roth IRAs are not subject to the required minimum distributions (RMDs) that apply to traditional IRAs.
Tax-free distributions and no RMDs could offer tax savings for the right situation, but they come at a hefty cost -- accelerated income tax payments on the conversion amount. The amount converted from a traditional IRA to a Roth IRA is subject to ordinary income taxes in 2010, or the income can be evenly split over 2011 and 2012, if elected.
Perhaps the most common tax planning move is to defer income to later years, capitalizing on the time value of money. So why choose to go against traditional tax planning methods to accelerate income and pay taxes sooner rather than later? For starters, the two advantages noted above are attractive. But, hands down, the most important reason one might convert a traditional IRA to a Roth IRA is because you expect to pay taxes at lower rates in 2010 (or 2011 and 2012) than in the future. Paying taxes at lower rates combined with the promise of tax-free growth on the converted amount can make accelerating tax payments well worth it.
Another reason one might convert a traditional IRA to a Roth IRA is because basis exists in their traditional IRA. This is common for taxpayers who have made non-deductible IRA contributions in the past and may create an opportunity to convert from a traditional IRA to a Roth IRA at little or no tax cost.
There are plenty of tax and financial considerations that come into play when determining whether a Roth IRA conversion makes sense. The technical rules can be complicated and different strategies will be better suited for different individuals as both investors and taxpayers. A Roth IRA conversion can be a great long-term tax planning strategy for the right client.
We have been reviewing clients' tax returns to look for tax planning opportunities. This includes Roth IRA conversions for clients with income below the $100,000 mark. For 2010, we will be looking to see if a Roth IRA conversion makes sense for all clients, regardless of income.