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2011 Roth IRA Conversion Rules

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In 2010, the income limit for Roth IRA conversions famously disappeared. Many people, who had been forced to get a traditional IRA because of higher income could convert that traditional IRA to a Roth version. It is still possible, in 2011, to convert your traditional IRA to a Roth IRA. Additionally, you are still able to rollover a 401k into a Roth IRA without the intervening step of rolling your 401k into a traditional IRA, and then converting the traditional IRA to a Roth.

However, there is a key difference: You can’t spread out the tax payments associated with your Roth IRA conversion. Before you decide whether a conversion to a Roth IRA is a good idea, consider the tax implications, and how you might be affected by making the move.

Paying Taxes on Your Roth Conversion

One of the things you have have to consider before you decide to go through with a conversion is the tax implication. Contributions to a traditional IRA are general made with pre-tax dollars. This means that you get a tax deduction immediately. The Roth IRA contributions, though, are made with after-tax dollars, and the earnings grow tax-free. That means that when you convert, you will have to pay taxes on the money from the traditional IRA.

In 2010, though, you had the option to spread the tax payments out over two years. If you had made a Roth conversion then, you could have spread the tax liability out, reducing the immediate impact on your pocketbook. In 2011, though, you don’t have that option. Instead, you have to pay the taxes on the conversion amount (which is treated like a withdrawal) immediately — no putting it off.

Before you convert, you need to consider whether or not it makes sense to do so, and whether you can handle the additional hit you will take to your finances by paying for the conversion. However, if you think that taxes will rise in the future, it might be worth it pay some tax now, and not have to pay the higher rate on withdrawals from a traditional IRA during retirement. For some, though, it makes more sense to forgo the conversion, and pay the taxes in smaller increments, later on.

Recharacterization

Some might convert the the traditional IRA to a Roth IRA, and then regret it. If you change your mind, you can decide to recharacterize your conversion, and go back to having a traditional IRA. However, there are limits. You can only recharacterize if you do so by October 15 of the following year. So if you convert in 2011, you can only take it back if you do so by October 15, 2012. Realize, though, that you can’t reconvert back to a Roth IRA in the same tax year as your recharacterization back to a traditional IRA, and you have to wait at least 30 days to switch back to the Roth.

What you decide to do depends on what you think is most likely to help you in the long run. It can help to talk to a financial professional to get the ins and outs of conversion and recharacterization so that you have a better idea of what might work best for you in terms of saving on your tax liability.

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9 Responses to “2011 Roth IRA Conversion Rules”

  1. billsnider says:

    I converted some of my traditional IRA money to ROTH IRA accounts. Note that I am retired and a few years away from mandatory withdrawals. I did it for three reasons.

    (1) My state (NY) allows me to deduct the first $20,000 per person per year. So my wife and I each converted at least $20,000. We get this benefit for each year that we do this. At a tax rate of about 8%, we saved $3,200 in 2010 and will save the same in 2011.

    Second, I will pay at a lower tax rate compared to the future by lowering the amount in subsequent years (my income will go up due to the IRA MRD). I determine the amount based on the difference of my income to the maximum amount in my current tax bracket.

    Third, in my opinion, I believe that tax rates will rise in future years to help pay down the bloatred deficit. So I choose to pay now.

    Bill Snider

  2. ICan'tThinkofaCleverName says:

    My wife and I are not eligible for the pre-tax deductions for IRA contributions due to the salary cap. We, therefore, place $5,000/year each into a traditional IRA then convert it to a Roth at the end of the year. There’s a minimal tax load (only if we have capital gains) since we put post tax funds in. It’s a no brainer for us. I am sure the feds will eventually change the rules and this benefit will go away.

  3. Annie says:

    Converting to a ROTH IRA makes sense depending on what your tax bracket is. You then will earn the dividends, income and growth tax free. A ROTH instead of an IRA for a young person makes sense as it will grow year after year. If confused whether to make the conversion consult with your CPA or Financial Adviser they should be able to tell you if it makes sense for your situation.

  4. And for those who don’t have a past Traditional IRA, but earn too much to make a direct Roth IRA contribution – you can make an effective “back door” contribution by making a non-tax deductible contribution to a Traditional IRA, then immediately converting it to a Roth IRA (since anyone, regardless of income, can make non-tax deductible contributions to a Traditional IRA). Keep in mind, however, that it’s not this simple if you have an already established Traditional IRA funded with tax deductible contributions. If this is the case, you will likely owe taxes upon conversion.

    • sophomore says:

      This comment seems at variance with the article. The first paragraph of TFA has: “Additionally, you are still able to rollover a 401k into a Roth IRA without the intervening step of rolling your 401k into a traditional IRA, and then converting the traditional IRA to a Roth.” Can someone provide a reference (e.g. Pub 590) that shows the IRS approved route?

  5. Kevin says:

    Tax consequences of the coversion should be taken in consideration of the big picture. Not that they should ever be entirely ignored, but only that there may be other issues that are more important. Tax diversificaton is one such issue.

    Since no one knows what tax rates and retirement provisions will be in the future (especially the distant future) it’s best not to restrict retirement investments to fully tax deferred accounts alone.

    A mix of tax deferred accounts, partially deferred accounts–the Roth IRA–and even non-retirement investments should be part of the investment mix. Shifting money into Roth accounts might make sense even with a current tax liability. The prospect of no tax liability after age 59.5 is worth paying some taxes for now.

    is imposed on Roth accounts in the future, amounts contributed before this occurs will most likely be grandfathered and not taxed. If that’s the case, we might be looking at a one time window of opportunity with the conversions.

  6. Kevin says:

    Tax consequences of the coversion should be taken in consideration of the big picture. Not that they should ever be entirely ignored, but only that there may be other issues that are more important. Tax diversificaton is one such issue.

    Since no one knows what tax rates and retirement provisions will be in the future (especially the distant future) it’s best not to restrict retirement investments to fully tax deferred accounts alone.

    A mix of tax deferred accounts, partially deferred accounts–the Roth IRA–and even non-retirement investments should be part of the investment mix. Shifting money into Roth accounts might make sense even with a current tax liability. The prospect of no tax liability after age 59.5 is worth paying some taxes for now.

    Even if some form of taxations is imposed on Roth accounts in the future, amounts contributed before this occurs will most likely be grandfathered and not taxed. If that’s the case, we might be looking at a one time window of opportunity with the conversions.


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