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What to consider when converting to a Roth IRA


Roth IRA advantages could offset expected tax increases

This new conversion option presents both tax planning opportunities and challenges for 2010, 2011 and 2012. You have to be a bit of a prognosticator about your individual income levels and tax rates in 2010 through 2012 to anticipate the effect of a progressive tax system on veterinarians' higher income earning expectations.

Effective for 2011, the Obama administration has proposed to increase the income and capital gains tax rates on single individuals with incomes of more than $200,000 and married couples with incomes exceeding $250,000. Taxpayer veterinarians would likely fall into those groups, including owners of shares of Sub Chapter S corporations or unincorporated small businesses from which they recognize income on individual returns.

For some taxpayers, their tax rates may rise after 2010 even if their income does not. President Obama has proposed, and Congress is expected to enact, legislation to restore the top two pre-2001 marginal income tax rates after 2010. If restored, the top two brackets will be 39.6 percent and 36 percent after 2010.

Conversion results in more tax now, less tax later

The conversion option could represent a significant tax advantage, especially when anticipating expiration of high bracket income tax rate reductions enacted in 2001. In addition, unlike a withdrawal from a traditional IRA, a conversion does not trigger a 10 percent early withdrawal penalty.

Be aware, tax laws require that you treat traditional IRA conversion as a taxable distribution, calculating the tax as if for ordinary income at your highest marginal tax rate. In effect, this conversion tax accelerates the taxable income that would eventually be paid on distributions from a traditional IRA upon retirement. The benefit is that you don't pay tax on any future appreciation in the value of the Roth retirement account.

Consider deferring your conversion taxes

While the conversion to a Roth IRA does trigger immediate taxable income, Congress has provided a special incentive in 2010 to encourage Roth conversions. In 2010 (and 2010 only), you have the choice of recognizing your conversion income in 2010 or averaging it over 2011 and 2012. Averaging it over two years enables you to pay the tax on the converted amount ratably over two years, instead of recognizing it all as income in 2010. The tax is assessed at the rates in effect for 2011 and 2012 when you take the delayed two-year option.

Consequently, taxpayers who have completed 2010 conversions will want to examine their personal circumstances and current tax law before filing their 2010 returns to decide whether to elect payment of the full tax on the Roth conversion on the 2010 income tax return at 2010 income tax rates. You may delay that decision to as late as Oct. 15, 2011, the last date for filing the individual tax return with maximum legal extension. Be aware, even if you delay your decision, you still need to pay the full 2010 estimated federal tax liability by April 15, 2011.

Is conversion right for you?

You may be interested in converting your traditional IRA to a Roth IRA if any of the following are true for you:

  • You can afford the tax on the converted amounts;
  • You anticipate being in a higher tax bracket in the future than you currently are; and
  • You have a significant amount of time before reaching retirement to allow assets to grow tax-free and recoup dollars that may have been lost due to the conversion tax.

Besides death and taxes, one thing is certain: an increase in complexity and the burden of compliance require that you find expert help. Please consult with your accountant or personal financial planner to ascertain the significant number of tax (including state income tax) and financial considerations that come into play when determining whether to convert all or part of your traditional IRA to a Roth IRA.

Made a mistake? Hit unwind

It is also possible to "unwind" the conversion and switch the Roth IRA back to its original traditional IRA form before you file the return. Converting now and having a variety of options later likely gives taxpayers the greatest flexibility for planning.

Dr. Heinke is owner of Marsha L. Heinke, CPA, Inc. and can be reached at (440) 926-3800 or via e-mail at

For a complete list of articles by Dr. Heinke, visit dvm360.com/heinke.


Source: DVM360 MAGAZINE,
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