Tax Newsletter Summer 2010

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OPPORTUNITY FOR 2010 TAX PLANNING WITH ROTH IRA

            You as a taxpayer have a unique opportunity this year to do long-term retirement planning under very favorable conditions. For 2010 only, it is possible to roll over funds from a traditional IRA into a Roth IRA without penalty and to postpone taxation of the rollover until 2011 and 2012. Also, for the first time, there is no income limitation for IRA to Roth rollovers. Prior to 2010, only those persons with adjusted gross income of  $100,000 or less could convert to a Roth.

            Roth IRAs are different from traditional IRAs because they are more liquid—you can pull money more easily out of a Roth before retirement age without penalty, after you have had the Roth for more than 5 years. Also, earnings on a Roth may never be taxed at all if you do not withdraw the earnings portion until after age 59 ½. With Roths, you have no minimum distribution rules, so you do not have to withdraw funds at age 70 ½ if you do not want to.

Another major difference is that Roth IRAs are funded with after-tax money. You get no deduction for contributions to a Roth. So when you convert a traditional IRA, which has never been taxed, into a Roth IRA, you must pay the income tax on the portion of the account that was funded with pre-tax dollars.

Special 2010 Income Splitting Rule

            The traditional IRA rules impose a 10 percent penalty on any unqualified withdrawal before age 59 ½. The special 2010 rule allows you to move funds from your traditional IRA into a Roth IRA without paying the 10% penalty. Even better, you do not have to pay the regular income tax on the rollover in 2010. You can elect to pay ½ in 2011 and ½ in 2012, spreading the income tax hit over two years. You also can make the rollover and then change your mind and undo the rollover anytime up to the 2010 filing date, including extensions of time to file. Therefore, you could wait until as late as October 15, 2011 to make the final decision.

Strategies

            You must consider where you will get the money to pay the extra tax if you decide to rollover your IRA into a Roth. Also, you should elect the two-year income split if a one-year rollover would push you into a higher tax bracket. If you already are in a high bracket, you may want to take the entire rollover amount into income in 2010 since it is possible that tax rates may increase for higher income individuals in 2011 when the Bush tax cuts expire. If you expect to be in a lower tax bracket in 2010 because of a job loss or other reduction in income, you may want to take all of the rollover into income in 2010. Again, you must have a source of funds to pay the income taxes. Finally, if you have other losses, such as net operating losses from a business, it may be time to make the switch to a Roth. These losses can help offset the increased income from a Roth conversion.

Act Fast

            Time is running out to make these decisions. Please contact me and I will evaluate your situation to help you decide if making the special 2010 Roth IRA conversion is beneficial for you. Below is a list of what can and cannot be rolled over into a Roth IRA.

What Can and Cannot Be Rolled Over Into a Roth IRA

It is important to know what assets can and cannot be rolled over into a Roth IRA. Here’s a run down:

The following items CAN be rolled over into a Roth IRA:

          ● Funds held in another Roth IRA.

          ● Funds held in a traditional IRA.

          ● A Simplified Employee Plan (SEP) or Simple IRA (two years after establishment).

           ● A rollover distribution from an employer retirement plan.

            ● An eligible rollover distribution from a plan where the taxpayer is a beneficiary.

  The following items CANNOT be rolled over into a Roth IRA:

           ● Required minimum distributions (RMDs) from any plan, including inherited IRAs.

            ● Hardship distributions.

            ● Yearly annuity distributions paid over a taxpayer’s life expectancy or over 10 years or more.

          ● Deemed distributions resulting from a default on an employer plan loan.

          ● Dividends on employer securities.

          ● Corrective distributions of excess contributions made to a plan.

 Special Rule for Inherited IRAs

        If a taxpayer inherits an IRA from his or her spouse, the taxpayer can elect to treat it as the taxpayer’s own plan and can roll it over into a Roth IRA. If a taxpayer inherits an IRA from anyone besides a spouse, it may not be rolled over into an inherited Roth IRA.

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Information provided by the National Society of Tax Professionals