In a prior blog post ROTH vs. Traditional IRA David Cash explained the difference between Traditional IRAs and Roths but this post will focus on the new conversion rules.

Starting in 2010 high income individuals can now convert their traditional IRAs to a Roth IRA. Prior to 2010 individuals with AGI over $100,000 could not convert traditional IRAs to a Roth IRA but could directly transfer from a Roth 401(k) to a Roth IRA. If a taxpayer converts their traditional IRA to a Roth they will have the choice to either pay the tax in 2010 or delay the tax to 2011 and 2012 but cannot do both.

The default tax treatment will defer paying the tax to 2011 and 2012 so for example if the taxpayer wishes to convert $100,000 in 2010 the taxpayer will pay tax on $50,000 in 2011 and $50,000. If the taxpayer wishes to pay the tax in 2010 the taxpayer will have to make an election to have the entire distribution taxed in 2010.

(Planning Note) It will be an advantage to convert now and push the tax to future periods if you can reasonably project your income to determine the appropriate amount to convert. In addition, many believe that since their investments may have suffered a decline in prior periods, now would be the time to get the funds growing. One issue that may not be obvious is that the election to pay the tax in 2010 is an all or none election so if the taxpayers wishes to convert and pay tax on the conversion in 2010 plus pay on an amount in 2011 and 2012 they will not be able to do so. However, if the taxpayer’s spouse has a traditional IRA they will be able to make their own election and pay the tax in 2010.

(Real life example) A client called and asked if it would be a good time to convert. Prior to 2010 the client’s income was over $100,000 and could not convert. The client also recently donated a conservation easement and would be entitled to a large charitable deduction. The client is concerned that he will not be able to use the charitable deduction within the 5 year carry forward period before it expires. A charitable deduction for an easement is limited to 50% of AGI so the utilization of the deduction is based on the taxpayers AGI. I determined that the client could contribute $40,000 in 2010 and $57,000 in 2011 and $57,000 2012 for a total conversion $154,000 in 2010. This allows the client to have the future value growth in the Roth IRA. The client wanted to convert as much as possible while still staying in the 15% federal tax bracket and wanted to make the conversion as soon as possible. However, the law prohibits the client from making a conversion in 2010 if he wanted to pay tax on the conversion in 2011 and 2012. Luckily the taxpayers spouse also had a traditional IRA and was able to make the conversion on the $40,000 in 2010. The taxpayer’s spouse will have to make an election to pay the tax on the conversion in 2010.

There are many reasons to convert a traditional IRA to a Roth, but, with most tax planning decisions it is critical to enlist the advice of a professional before executing any tax strategy. Please feel free to contact any of the accountants at Cook Martin Poulson, PC to discuss how this strategy would affect you.

Authored by Troy R. Martin, CPA, Shareholder of Cook Martin Poulson.


 

 

 

Authored by David Cash, CPA, MAcc. Dave has worked in both offices of CMP. He spent 2 years in the Logan office and has been in the Salt Lake office for 3 years. Dave specializes in oil and gas taxation, and individual and business tax planning and compliance.

 
When a taxpayer is not offered a retirement plan through their work place many taxpayers that still want to save for retirement are faced with one major decision…what type of IRA do I want?

 
As with most questions in the world of taxation, this is a question that can only be answered by “It depends.”

 
It depends on the personal situation of the taxpayer and what expectations they have for the future. Let’s start with the major difference between these two types of IRA:

 
A ROTH IRA is one where the contributions are taxed, but the earnings can be tax free.

 
A Traditional IRA is one where the contributions are deductible, but when the money is distributed from the IRA then the entire distribution is taxable.

 
Taxpayers that would be ideal to chose the ROTH IRA would be someone:

1. That is younger (more years for earnings to grow in the IRA),
   
2. That may need to use the contributions prior to age 59 ½ (contributions can be withdrawn tax free prior to age 59 ½)
   
3. In a low tax bracket (a bet that they will be in a higher tax bracket when they withdraw the money tax free), or
   
4. Someone that doesn’t expect to need the money in retirement (maybe you will get a big inheritance and you want your savings to go to your heirs and you don’t want to have Required Minimum Distributions).
   

Taxpayers that would be ideal to chose the Traditional IRA would be someone

1. That is in a higher tax bracket (needs or wants the tax deduction now),
   
2. Someone that actually wants to save the money for retirement (most distributions prior to age 59 ½ are subject to a 10% early withdrawal penalty)
   
3. Someone whose income exceeds the limit to be allowed to contribute to a ROTH IRA (for 2010 people who file Married Filing Joint can’t contribute to a ROTH if their Modified Adjusted Gross Income is over $177,000), or
   
4. Someone who expects their tax bracket to be lower when they retire (you don’t want to pay tax at 35% when you may be able to pay tax at 10% when you retire).
   

There are many aspects to consider when deciding what type of IRA is best for you. The biggest reason why most accounting questions, including this one, are answered with “It depends” is that what may be best for you may not be best for your next door neighbor. People and situations are different and in the world of retirement contribution options one size does not fit all.