What to consider when converting to a Roth IRA

What to consider when converting to a Roth IRA

Oct 01, 2010

Crosswords: Traditional IRA to Roth IRA conversions present 2010 tax planning complexities with potentially many years of impact. Here's what you need to know.
By now, you have likely heard about Roth IRA regulation changes that might affect you. And you likely have questions about what you should do in response. To help, here's an overview of just one of many complex tax-planning issues presented in the flurry of massive tax legislation over the last nine months.

Tax code changes remove limitations

The biggest change regarding Roth IRAs is that for the first time since the introduction of the Roth IRA in 1998, all taxpayers, regardless of income and filing status, are eligible to convert a traditional IRA to a Roth IRA. Starting in 2010, tax code eliminates the modified adjusted gross income (MAGI) and filing status requirements limiting Roth IRA conversions.

Before, these limits prevented many veterinarians from using or converting to a Roth. Only individuals with MAGIs of $100,000 or less could convert amounts in their traditional IRAs to Roth IRAs. For tax years beginning in 2010, the $100,000 adjusted gross income (AGI) limit on conversions of traditional IRAs to Roth IRAs is eliminated completely. This special treatment gives everyone, regardless of his or her income level, the opportunity to convert a traditional IRA to a Roth IRA.

Moreover, until 2010, tax laws prohibited married taxpayers filing separate returns from converting their traditional IRAs to Roth IRAs. New tax code also lifts this filing status restriction, allowing married taxpayers who file separate returns to convert traditional IRAs to Roth IRAs.

Roth IRAs offer advantages

You might want to convert your traditional IRAs to Roth IRAs for a variety of reasons. Roth IRAs have two major advantages over traditional IRAs.

First, Roth IRA distributions are tax-free if they are qualified distributions. To be qualified, distributions must be made after a five-year holding period has passed and after the account holder reaches age 59.5 or on account of death, disability or the qualified purchase of a first home.

Second, Roth IRAs are not subject to the required minimum distribution (RMD) rules that apply to traditional IRAs (as well as individual qualified plans). Therefore, a Roth IRA account holder who reaches age 70.5 does not need to begin taking distributions; instead, the funds can continue to grow tax-free until you need them or pass them on to heirs.

The tax-free nature of qualified Roth IRA distributions may prevent you from paying taxes dictated by a higher tax bracket that would otherwise apply if you were withdrawing taxable distributions from a traditional IRA. Moreover, these distributions—unlike those from traditional IRAs—do not affect the calculation of tax you owe on Social Security payments and do not affect deductions based on AGI.