Changes to Roth IRA Conversions

When Congress created the Roth IRA a decade ago, it seemed like a good financial move to convert a traditional IRA, where assets and earnings are tax-deferred, to the new Roth, where earnings and subsequent withdrawals are tax-free. The law put a couple of obstacles in the way, however.

When Congress created the Roth IRA a decade ago, it seemed like a good financial move to convert a traditional IRA, where assets and earnings are tax-deferred, to the new Roth, where earnings and subsequent withdrawals are tax-free. The law put a couple of obstacles in the way, however. The primary deterrent was the federal income tax due on any pre-tax contributions to the traditional IRA, and on any earnings. For most taxpayers, this meant that all the assets in the traditional IRA would be taxed, which could amount to a hefty tax bill. There was also another barrier for upper-income individuals—those with an adjusted gross income of more than $100,000 were barred from converting to a Roth. Taxpayers with an AGI of more than $110,000 ($160,000 for married joint filers) found themselves in a double bind: in addition to being unable to convert a traditional IRA to a Roth, they couldn’t fund a Roth IRA either.Fast forward to 2006, when Congress passed sweeping changes to the tax laws, including revised rules governing Roth conversions. The new rules allow anyone, regardless of income, to convert a traditional IRA to a Roth. The catch is that the conversion must take place in 2010 and only in 2010. It gets better: the taxable income from the conversion can be spread over 2 years, with half going on the tax return you file in 2011 and the other half reported in 2012. The income restrictions on funding a new Roth will still apply, but tax experts suggest that a way around that is to start funding a non-deductible traditional IRA now with the intention of converting it to a Roth in 2010.