Roth IRA conversions are about to become a big deal for people saving and investing for retirement. Under the Tax Increase Prevention and Reconciliation Act of 2005, or what some lovingly refer to as TIPRA, all taxpayers will be able to convert all or some of their traditional IRAs into Roth IRAs, regardless of income.
This is a game-changer, some are saying. So much so that companies and experts are fast at work training legions of advisers on the ins and outs of Roth IRA conversions. And soon these advisers will start pelting you with phone calls, e-mails and snail mail asking to schedule an appointment with you to talk about your IRA and the opportunity of a lifetime -- the chance to pay taxes now as a way to avoid paying more taxes later.
"The time to start clients planning is now as advisers look for practical and actionable strategies to address today's unprecedented market conditions," wrote Kevin O'Fee of Lincoln Financial Group in a recent article.
"TIPRA is reason to re-engage with those high-income clients by challenging the traditional rules of retirement, legacy planning and asset allocation. As such, advisers and clients alike will be well-served by evaluating the potential benefits of a Roth IRA conversion," O'Fee said. Read the article here.
We also think you'd be well-served with answers to some of the most frequently asked questions about Roth IRA conversions -- before those advisers take O'Fee's advice and come a-callin'.
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1. When do you report the income?
Prior to 2010, the amount converted would be reported as income on that year's tax return. Under TIPRA, however, conversions done in 2010 don't have to be reported on your 2010 tax return. Instead, you get to report the income on your 2011 and 2012 tax returns, said Barry C. Picker, a certified public accountant and financial planner with Picker, Weinberg & Auerbach, CPAs, and the author of "Barry Picker's Guide to Retirement Distribution Planning."
Thus, if you converted a $100,000 IRA in 2010, you would report $50,000 in ordinary income in 2011 and $50,000 in 2012. In the parlance of advisers, you get to split the income.
If you do a Roth IRA conversion in 2011 or later, you don't get to spread the income or tax bill over two years. And that's why folks in the industry are salivating over this one-year-only bargain.
2. When do you pay the taxes?
If you split the income, you have to pay the taxes due on your 2011 and 2012 tax returns.
3. Do you have to split the income?
No. If you think splitting the income will create a larger overall tax bill, you can opt out of splitting the income over two years, Picker said.
4. If you elect out of the two-year split, is it all or nothing, or can you do it piecemeal?
According to Picker, it's an all-or-nothing election.
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5. What happens if you convert to a Roth IRA when there is basis (the original amount invested) in the traditional IRA but it's worth less?
According to Picker, there is no official guidance on this question.
"There appear to be two possibilities, but in any event if the account is worth less than the basis, there will be no income on the conversion," Picker said. "In one possible scenario, the taxpayer could take a miscellaneous itemized deduction for the loss in value, similar to the situation where the taxpayer had cashed out the entire account. In that scenario, the basis in the Roth IRA would be the value at the time of conversion," he said.
"The other possible scenario is that there would be no loss recognized on the conversion, but in that case the basis in the traditional IRA would carry over to be the basis in the Roth."
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