We anticipated that 2010 would be the year of the Roth IRA conversion and we were not disappointed. Merrill Lynch recently announced that their client conversions in 2010 were five times greater than the amount converted in 2009. Several other IRA providers also reported similar gains in conversion activity, such as Fidelity Investments, which reported a four-fold increase in 2010 conversions compared to those done in 2009.
This is not at all surprising when you consider that 2010 was the first year anyone with a traditional IRA or access to funds in certain employer-sponsored retirement plans could convert. Previously, individuals with adjusted gross income of more than $100,000 or those submitting their income tax returns as “married, filing separate” were not eligible to convert. These restrictions were eliminated beginning in 2010, opening up the conversion spigot for everyone.
Individuals who converted in 2010 will spread the resulting taxable income in equal amounts over two years, 2011 and 2012. For those not wishing to do that, an election can be made to include all the taxable income in 2010. The removal of conversion eligibility roadblocks and the ability to spread income over two years proved to be powerful incentives to convert in 2010.
Good news for those who converted in 2010 came late in December 2010 when Congress voted to extend the Bush era tax rates, the result of which means income tax rates will remain the same for the next two years. Many were fearful that income tax rates would increase. Now that that won’t happen, individuals who converted in 2010 will probably not elect out of the two year spread of income in 2011 and 2012, unless they expect to be in a higher tax bracket during one or both of those years.
Taxpayers who converted in 2010 and file their 2010 income tax return on time (with or without an extension) will have until October 17, 2011, October 15 falls on a Saturday this year, to undo their Roth conversions. The most obvious candidates for reversals, known officially as “Roth recharacterizations”, are individuals whose accounts have fallen in value since the conversion or those who simply just have a change of heart.
If you converted in 2010, mark your calendars for October 17, 2011. You will have up until then to simply undo part or all of your conversion as if it never happened. If only things were that easy at the race track.
By IRA Technical Consultant Marvin Rotenberg and Jared Trexler
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*Copyright 2011 Ed Slott and Company, LLC
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