Roth Conversions Highlight Mailbag

This week's Slott Report Mailbag discusses the main IRA topic that will dominate year-end planning...a 2010 Roth conversion. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure.

Now, on with our consumer questions.

1. Dear Mr. Slott and Company,

Is it a good idea to do a Roth conversion of part of my 403(b) accumulation even though in one year's time I will be subject to RMD (required minimum distributions)? I am just turning 69.

Much of my money is in tax-deferred 403(b) accounts. I have a stable pension that is not taxed by my state. Does it make sense to convert some part of my 403(b) accumulation now ($50,000 for example) in order to avoid RMD in the future? If I do so. I would pay the tax on it over 2011 and 2012 using outside money. I am a single taxpayer and do not anticipate needing any income for at least several years. Nor are my heirs a consideration in this decision.

Sincerely,

Janet Hilowitz

Answer:
The decision to go a Roth conversion is partly mathematics and partly what your goals and estate plan are. Generally, the math says that a Roth conversion is the better option for an individual, especially if you can pay the income tax due on the conversion from non-IRA funds. So that leaves you with fitting the Roth conversion into your long-term goals and your estate plan. A Roth conversion would reduce your income in future years by eliminating the RMD on the converted funds. This would reduce your annual income tax bill as well. And if you needed extra income at any time, a distribution from the Roth IRA would be income tax free and maintain that lower tax level. It would be best if you consulted with your tax or financial advisor to discuss all the pros and cons of doing a conversion based on your circumstances. You can find a list of Ed Slott-trained advisors on our website, www.irahelp.com.


2.

Ed and Company,

1. Is there a way to pay a portion of a 2010 Roth conversion tax in 2010 AND consider the remaining portion eligible for the 2011/2012 deferred conversion tax? This would allow me to finalize my Roth conversion in 2010 and pay the conversion tax over THREE years.

2. If I were to elect the 2011-2012 Roth conversion tax on a 2010 conversion, would I still be eligible for a recharacterization if needed in 2011 and/or 2012? If yes, can it be a recharacterization of just a portion of the converted amount?

Thanks!

Answer:
1. No. The only two options available to an individual are to pay all of the tax in 2010 or to split the income over 2011 and 2012. Spouses, however, can make different elections.

2. The recharacterization rules say that a recharacterization can be done up to October 15th of the year after the conversion if the tax return is on extension and the income tax is paid by April 15th. A 2010 conversion can only be recharacterized up to October 15, 2011.


3.

Ed,

I am a retiree and want to know if I contribute to a Roth IRA with no "w2" income, but with a company pension income and taxable Social Security income?

Thank you very much.

Dwight Youngberg

Answer:
IRA contributions can be made ONLY if you have earned income. The safe harbor is W2 income. Pension and Social Security income are NOT considered earned income. If your spouse has enough earned income, a contribution can be made based on her income. Contributions can be made to a Roth IRA regardless of age (as long as you have earned income and income does not exceed certain levels). Contributions to IRAs cannot be made once you reach the year you turn 70 1/2.

By IRA Technical Consultant Beverly DeVeny and Jared Trexler
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*Copyright 2010 Ed Slott and Company, LLC