Do you have a Traditional IRA?

If you do, you may have an important decision to make before December 31, 2010. That decision is, “Do I convert my traditional IRA to a Roth IRA”. To help in this decision making process, it is necessary to know the tax aspects of converting to a Roth IRA.

Roth IRAs contain certain advantages over traditional IRAs in that they provide income tax benefits that you cannot receive from a traditional IRA. If certain conditions are met, such as the five year holding period or distributions received after age 591/2, death, disability, or use for a first time home purchase (within limits), distributions from a Roth IRA are received tax free. Additionally, Roth IRAs generally are not subject to the required minimum distribution rules and there is no age requirement for setting up or making contributions to a Roth IRA.

So why is December 31, 2010 important? To answer this question, some background would be helpful. Before January 1, 2010, Roth conversions were not allowed for taxpayers whose adjusted gross income exceeded $100,000. Beginning January 1, 2010 the conversion was available to everyone who wanted to take advantage of converting their traditional IRA to a Roth. Therefore, more taxpayers have the opportunity to take advantage of this conversion feature. It must be noted that any conversion of a traditional IRA to a Roth results in a taxable conversion, unless some part of the traditional IRA had been a non-deductible contribution. This is where December 31, 2010 becomes important. Since a conversion is a taxable transaction, taxpayers who convert their traditional IRA to a Roth IRA in 2010 have the option to defer and split the taxable income resulting from the conversion and report half of the income in 2011 and the other half in 2012 or elect to have the entire income reported in 2010. The deferred income would be added to the taxpayer’s other taxable income in 2011 and 2012 and taxed at the income tax rates that will be in effect at that time.

Not knowing what future tax rates may be, it would be wise for any taxpayer who is considering converting a traditional IRA to a Roth IRA to consult with one of our tax professionals and learn more about this process and the tax effects it may have on you.

/posted by Wayne Sturgeon, CPA