2010 Planning Observations for Traditional IRA Conversions into Roth IRAs
TRADITIONAL IRS (TIRAs) CONVERSIONS INTO ROTH IRAS (RIRAs)
1. In 2010, a conversion of a TIRA to a RIRA is available without regard to the amount of the TIRA owner’s income.
2. A 2010 TIRA conversion to a RIRA is taxable in 2011 and 2012 (50% of the taxable amount in each year). However, prior to the taxpayer filing his or her 2010 federal tax return, a taxpayer may elect to include in 2010 taxable income the full amount of the income attributable to the 2010 conversion. If such an election is made, the taxpayer should review the potential liability for 2010 estimated tax underpayment penalties.
3. A TIRA conversion to a RIRA will be less beneficial where income tax from the conversion will be paid from the TIRA distribution. Therefore, a TIRA to RIRA conversion is most beneficial when the income tax attributable to the conversion is paid from non-TIRA and non-RIRA assets. This condition is also true where 401(k) plan balances are transferred to a RIRA (see 8.).
4. A conversion to a RIRA is not permitted for a TIRA that is inherited from a person other than the TIRA owner’s spouse.
5. RIRAs are funded with after-tax contributions (from a taxable TIRA conversion). The amount of after-tax contributions can be withdrawn anytime without tax liability or penalties.
6. If you receive a distribution of earnings from a RIRA, you’re required to pay tax (and possibly penalties) unless you received a qualified distribution, which is based on a (i) type of distribution test and a (ii) five-year test. The five-year test is satisfied beginning on January 1 of the fifth year after the first year you establish a RIRA. For example, if you established a RIRA in 2004, any distribution from a RIRA will satisfy the five-year test if the distribution occurs on or after January 1, 2009. Even after you meet the fiveyear test, only certain types of distributions are treated as qualified distributions. There are four types of qualified distributions, those that are (1) made on or after the date you reach age 59½, (2) made to your beneficiary after your death, (3) in the event you become disabled, distributions attributable to your disability, and (4) qualified first-time homebuyer distributions.
7. RIRAs have no minimum distribution requirements. TIRAs require minimum distributions commencing at age 70½ years of age. RIRAs are generally not subject to income in respect of a decedent (IRD) tax liabilities in the event of a RIRA owner’s death. Also, if a TIRA owner does not need the TIRA assets to fund retirement or other cash flow needs, a larger asset balance could be available to beneficiaries who could take tax-free distributions over the beneficiaries’ life expectancies. If a surviving spouse is the beneficiary, distributions are not required during the life of the surviving spouse.
8. Traditional 401(k) account balances can be transferred to a RIRA. 401(k) plan participants should review with their plan administrators the availability of such a transfer. This transfer is taxable to the 401(k) account owner. However, if the transfer is from a designated Roth account in a 401(k) plan, there would be no tax liability arising from the transfer.
9. Generally, younger TIRA owners can attain greater aftertax RIRA balances post conversion, compared to older TIRA owners who convert. This observation assumes for each (younger and older) TIRA owner the same tax rate and investment rate of return (appreciation and yield) over the planning time horizon. This generalization is based on the ability to receive tax-free increases in the value of the RTIRA over a longer time period.
10. A TIRA conversion to a RIRA is more favorable where the income tax rates that the owner will be subject to will increase in future (post conversion) years. Conversely, if a TIRA owner’s tax rate is expected to decrease, the value of converting a TIRA balance to a RIRA is diminished. Other variables which should be considered are expected rates of return on assets outside the TIRA or RIRA and the expected rates of return within the TIRA or RIRA.
For more information, contact Timothy Speiss (212.891.4087) of Eisner Personal Wealth Advisors practice group.
This communication is not intended or written by Eisner LLP to be used as tax advice by any party. A tax advisor should be consulted and the facts reviewed in connection with, and prior to, any conversion of a traditional IRA to a Roth IRA. The comments in this outline are limited to the observations and comments specifically set forth herein and should be considered based on the completeness and accuracy of any actual investor’s stated facts, assumptions and representations. The outline is based on the current provisions of the Internal Revenue Code of 1986 and ERISA, the regulations thereunder, income tax treaties, and judicial and administrative interpretations thereof. These authorities are subject to change, retroactively and/or prospectively, and any such changes could affect the validity of the observations herein. Eisner LLP will not update this outline for subsequent changes or modifications to the law and regulation or to the judicial and administrative interpretations thereof.
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