Should You Convert to a Roth IRA in 2010?

I listened in on a Roth IRA Converstion conference call with a Charles Schwab representative this morning. offers a pretty nice resource for Roth IRAs.

In 15 days an opportunity will become available that will allow people at all income levels to convert a non-deductible IRA to a Roth IRA. Previously, that option was only available to those with modified AGIs of less than $100,000.

As the host of the conference call mentioned, there are definitely some things to think about before making the conversion:

1. Will you be in the same or higher tax bracket in the future when you begin making withdrawals? Of course none of us know what tax rates will be like in the future but I would have to say that they will be HIGHER. Factor in required minimum distributions (RMDs) from taxable plans (there are no RMDs with a Roth IRA) and you might be moved to a higher income tax bracket.

2. Do you have a long time-horizon? The longer the time horizon, the better. You have to factor in the opportunity cost of paying taxes now in order to receive tax-free income in the future.

3. Can you pay the tax on the conversion from sources outside the IRA? You’ll receive little benefit if you have to pull money out of the IRA to pay the income taxes on the conversion.

4. How will the conversion affect your AMT (if you’re subject to the AMT)? A good tax program like TurboTax or Tax Cut will help you walk through those scenarios.

5. Would you use the Roth as an opportunity to pass on assets to your heirs? If this is the case, then other issues may not be of importance to you.

One other thing that is significant about 2010 is that if you make the conversion in 2010, you’ll have the opportunity to have the conversion amount added to your income in equal amounts over the 2011 and 2012 tax years. For instance, say you convert an IRA to Roth IRA and the taxable amount is $50,000. You will be able to have $25,000 added to your income in 2011 and 2012. Of course, something to keep in mind is whether or not you’ll be in a higher tax bracket in those years and whether or not the conversion amount will throw you into a higher bracket.

Lot’s of stuff to consider.

If you have any questions, feel free to leave a comment. I’ll see if I can get the Schwab rep to answer them for you. In the meantime, check out Schwab’s Roth resource. Another helpful resource is IRS Publication 590 (PDF).

6 thoughts on “Should You Convert to a Roth IRA in 2010?”

  1. The conversion to a Roth IRA seems to be a good idea. Just wanted to see if you agree and also, if I may have more options.

    My wife and I have IRAs which had values in the thousands.

    My IRA is actually a 401K converted to IRA 10 years ago. Total deposits were greater than $10K, but current value has fallen now to less than $500.

    If I convert now to a Roth IRA, it seems that I have to show the $500 as additional income. Is there anything that can be done regarding the losses. I have all the paperwork that can show the tax basis. It is sad that I have losses yet have to pay tax on it as income and can’t deduct the losses like a standard brokerage account.

    Please let me know at the email provided. Thanks so much.


  2. @Ketan: In a sense, you’ve already deducted the losses on your account. You got a deduction for the full amount of income you contributed, but now you’ll only have to pay tax on a small amount when you convert. You’ve already gotten to reduce your taxes for that $9500 loss.

  3. Three things to note in the conversion:

    1) Higher tax rate isn’t just federal taxes but state and local taxes. If you plan to retire to Texas or Florida or other non-income tax state, the tax savings can offset any federal tax hikes.

    2) Federal taxes probably will go up but how will they do it? Lower exemptions and deduction or higher sales tax (move to VAT)? Some of these changes will not effect your inputted tax rate.

    3) The conversion will tax your change at the highest tax rate you are in (possibly put you in a higher tax rate). And, with phase-outs, the tax rate could be even higher. When you withdrawal money in retirement, it will be taxed at various tax rates (up to the highest tax rate). And, your income will probably be lower putting you in a lower tax bracket.

    This is not a slam dunk decision. You need to understand where you are at and where you will be.

  4. I just did a CPE webinar yesterday and this topic was included. Other points to consider on the conversion is that there is still a 5-yr holding period requirement, you can convert a 401k or other qualified plan (QP)as long as the QP allows a rollover to an IRA, and finally, you can do partial conversions, (you aren’t required to convert the whole balance.) This last point would fall under the “you can have your cake and eat it too!”

    As tempting as a conversion is, my (not my husband’s) balances aren’t very high and I’m not a proponent of paying any tax before I have to. I think I’ll just take my distributions down the road and hopefully my/our tax bracket will be low enough my taxes will be neglible or nil.

    One very important point to consider (that the CPE moderator couldn’t answer w/certainty yesterday) was the impact of this included conversion “income” now on your 1040 when submitting the FAFSA form for college aid. My opinion is it’s not worth converting until you have a definitive answer on this question of how any aid would be impacted. No good deed goes unpunished…

  5. Item 3 in Pete’s response is a good one to keep in mind. It certainly makes the calculations trickier.

    I am inclined to think that in the future people are more likely to be in lower tax brackets so deferring taxes to the future feels right to me. Of course, following a gut feeling is probably the worst thing an investor can do…

  6. @ETF Topics: Actually, as JLP says in the article, in the future it is almost a guarantee (I said “almost”!) that tax rates will be higher. We are currently in a period of extremely low tax rates and it certainly should not continue.

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