Thursday, October 21, 2010

Once-Per-Year Rule Question Highlights Mailbag

This week's Slott Report Mailbag discusses some complex, timely issues involving the once-per-year rule and the timing involved with opening a Roth IRA. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure.


I have the following question:

I worked for a local company from May 2005 through mid-December 2008. During this period, contributions were made by both myself and my employer into a 401(k). I changed jobs in December 2008, and executed a direct rollover of the 401(k) assets into a rollover IRA in January 2009. I opened a single 401(k) for myself in April 2008 for my sole proprietorship which I owned and operated. I closed that proprietorship in 2009, and rolled the assets of my single 401(k) directly into the same rollover IRA in January 2010. Do the once-a-year rules apply to all of the assets in the rollover IRA so that I cannot convert any of those assets into my Roth IRA this year? I opened the Roth IRA in January 2003.


Mark Haugen

Rollovers from a plan to an IRA are not subject to the once per year rule. The rule applies to IRA to IRA and Roth to Roth rollovers. You can convert your IRA assets to a Roth IRA at any time.


I anticipate a minimal tax burden for 2010 and 2011 due to a hiatus from work. Should I use this time to convert some or all of my 401(K) of $200,000 to a Roth IRA? I will not retire for several years. Should the conversion be in one lump sum in 2010 or should they be spread out over 2010, 2011 and possibly 2012?


It might be a good time to consider converting to a Roth IRA while your income is low. However there are other individual factors to consider. You need to be able to take a distribution from the plan so you should check with the plan to see if you even have access to those funds. You should also consult with a knowledgeable financial advisor in this area or your CPA to determine if a Roth IRA conversion is right for you.

If you convert in 2010 you will have the option of (1) add the taxable conversion amount to your 2010 income or (2) if you don't elect #1 you would add 1/2 the taxable income from the conversion to income in 2011 and the other 1/2 to income in 2012. If you don't include that amount in 2010 your only option is #2.


Ed and Company,

My taxable income for year 2010 will be approximately $75,000. My wife and I have IRAs of $50,000 each, total $100,000. We will need these funds to buy a second home. Our ages are 39 and 37. We do not Currently have a ROTH IRA. If we convert the IRA to a Roth IRA this year and then take a distribution of the new ROTH IRA in the year 2010, $100,000, does all of the $100,000 become income for the year 2010 and assuming there have been no gains can we pay the taxes due over two years. And can the $100,000 be split over two years, $50,000 for the year 2010 and 2011?

Your answer wold be appreciated.

Hal Goren

If you are going to withdraw all the funds you convert in the year of the conversion, then there is no reason to do the conversion in the first place. Yes, you can convert your IRAs to a Roth IRA in 2010. If you convert in 2010, only in 2010, you will have the option of adding the taxable portion of the conversion amount to your 2010 income tax return. Or if you do not include it in your 2010 income you must add 1/2 of the taxable conversion amount to your 2011 income and the other 1/2 in 2012. You can elect one method for your IRA and your spouse can elect the other method for her IRA or you both can elect the same method.

Doing the conversion does not get you out of the 10% early distribution penalty. Since you are in your thirties, you must hold the converted amount for five years before you can withdraw it and not pay the penalty. In addition, any earnings will be subject to income tax and the penalty. Also, you will not be able to spread the income over 2011 and 2012. A distribution from the Roth before the tax is paid will accelerate the income tax due. In your case, a distribution of the entire converted amount in 2010 will make that amount taxable in 2010. So you will end up in the same tax position you would be in if you simply took the distribution from your IRAs. You will owe income tax and the 10% penalty on the $100,000 withdrawal, all in 2010.

By IRA Technical Consultant Marvin Rotenberg and Jared Trexler
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