Like Milk, 2010 Has an Expiration Date
by Carol Schmidlin |
Of course, Roth Conversions can be done after 2010, but at what cost? The 2010 expiration date on Roth conversions is quickly approaching which means that beginning January 1, 2011; the best opportunities to reduce the tax on a Roth conversion may be behind us.
Unfortunately, the uncertainty of not knowing where tax rates will be next year is frightening many people into paralysis and may prevent them from taking advantage of favorable tax treatments only available to Roth conversions completed this year.
So the question begins with where will taxes be in 2011?
If the Bush tax cuts expire at the end of this year as they are scheduled to, there will be significant increases that apply to everyone, (at least those of us that pay taxes).
Under the Obama Plan, tax cuts will expire for families making over $250,000 a year (and singles over $200,000), as well as extending some stimulus measures and imposing new limitations on itemized deductions and the Democratic Plan described below.
The Democratic Plan proposes that Congress pass a tax bill that reflects the limits set by the Statutory Pay-As-You Go Act of 2010, passed earlier in the year by Congressional Democrats.
The Republican Plan wants Congress to pass the Tax Hike Prevention Act of 2010 (S.3773), which will fully extend all of the Bush tax cuts, and is supported by most Congressional Republicans.
Here is an outline of the major tax law provisions in 2011, under the above scenarios.
I recommend that you have a professional Roth conversion evaluation done by a qualified tax advisor. This professional should be asking you three important questions:
- When will the money be needed? (At least 10-15 year time horizon),
- What will future taxes be? (Compared to current tax rates), and
- Where will the money to pay the tax come from? Do you have enough funds available to pay the conversion tax? (Generally it is best to pay the conversion tax from non-IRA funds).
If you are advised that this type of proactive tax planning is beneficial to your situation, you’ll want to make sure the Roth conversion gets completed in 2010. Keep in mind that the funds from the Roth conversion must be in the Roth in 2010. Completing the Roth conversion paperwork in 2010 alone is not going to cut it unless the funds have been received in the Roth by year end 2010.
So what’s the big deal with not knowing where taxes are going to be next year? In regards to doing a Roth conversion this year, there is none! Why? Because you can have a do over and recharacterize your Roth back to a Traditional IRA next year. The deadline for recharacterizing a Roth IRA converted in 2010 is October 15, 2011. Does anyone think that by this date, we will know what our federal tax rate is for 2011? So if Congress’s decision on tax rates is unfavorable to you, you have the ability to recharacterize your Roth IRA back to a traditional IRA as long as it gets done by October 15, 2011.
Let’s review the two reasons why 2010 will go down in history as “The Year of the Roth Conversion:”
- Possible tax deferral.If you convert in 2010, you can choose between two payment options. You can pay all the tax on your 2010 tax return, or you can split the taxable income from the conversion evenly between your 2011 and 2012 tax returns. The ability to split conversion income over two years is a unique opportunity that is only available for 2010 Roth IRA conversions.
- Low tax rates. Under current law, taxes are scheduled to rise in 2011. The top federal income tax rate of 35%, will rise to 39.6%. In addition the new health care tax effective in 2013 could add an additional 3.8% surtax on investment income for high-income individuals. Although IRA distributions and Roth conversion income will not be subject to the 3.8% surtax, but may raise overall income above threshold limits subjecting investment income to the 3.8% tax.
If you are interested in learning about additional tax reduction strategies, and would like a copy of our white paper: “Tax Reduction Strategies for Retiring in 2010 and Beyond,” just send an email request.
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