By Laura Saunders
This year marks the first that taxpayers of all income levels can convert regular individual retirement account assets to Roth IRAs, where funds can grow tax-free. As retirement savers calculate the effects of the new tax package — and the likelihood that Bush-era tax cuts will stick around until 2012 — weighing the merits of a conversion has become more complex.
Recent articles and columns on the topic sparked a flood of reader responses, so The Wall Street Journal’s Tax Report columnist Laura Saunders reached out to Ed Slott, CPA, IRA expert and host of www.irahelp.com, for answers to some of her readers’ most pressing questions. The first four are below:
Q: My wife and I both made Roth conversions in 2010. If we file joint federal tax returns, can one of us apply the conversion to our 2010 return while the other splits the conversion on our 2011 and 2012 returns?
Ed Slott: Yes, you can each make separate elections because each spouse’s IRA is his or her own account. Each spouse would file an individual Internal Revenue Service Form 8606, where conversions are reported. The couple will thus file one joint tax return with two Form 8606’s attached (one for each spouse). However, one spouse cannot report some in 2010, and some over 2011 and 2012.
Q: In light of last year’s option to suspend IRA distributions, do we have to double up this year? Can the distribution we took last year replace this year’s contribution?
ES: You don’t have to double up this year. Still, you’ll never get credit for a prior year’s distribution. For example, some people were unaware that they did not have to take a required distribution last year. If they took say, $10,000, they receive no credit for that this year. The 2010 amount must still be taken in full.
Q: I am 26 years old. I qualify for the full $5,000 Roth IRA contribution for tax year 2010, but my modified adjusted gross income in tax year 2011 will be too high for me to qualify for a Roth IRA contribution in that year. I made the maximum contributions to my Roth account in tax years 2008 and 2009, but do not have a traditional IRA account. Is there a way for me to still contribute to a Roth in tax year 2011? In other words, am I able to open a non-deductible IRA and immediately convert that account to a Roth?
ES: Yes, you can contribute to a non-deductible traditional IRA and then convert to a Roth IRA because there are no longer any income limitations to do so. Still, you will have to consider your other IRAs to see how much of the conversion will be taxable. You cannot convert only your non-deductible IRAs — and pay no tax on the conversion — if you have other IRA funds. Each dollar converted will be a certain percentage tax-free based on the amount of your total non-deductible IRA contributions to the total value of all of your IRAs, including any SEP and SIMPLE IRAs you might have.
Q: I plan to purchase a condo in a few weeks. If I convert a portion of my standard IRA to a Roth in 2010, how soon can I use some of the Roth for the 20% down?
ES: This sounds like a bad idea. IRA funds are for retirement — it’s not worth paying the tax on a Roth conversion only to pull the funds out immediately. Also, if you were planning to use the two-year deal (including the income from a Roth conversion in 2011 and 2012), taking a distribution in 2010 from a 2010 Roth conversion will blow a good part of that deferral because the Roth conversion income will be accelerated.
That said, yes, you do have access to your converted funds immediately, and the distribution will be tax-free because you paid the tax when you converted. But if you are under age 59 1/2 and have not held those funds for at least five years, you will pay a 10% penalty on any converted funds withdrawn. If you are age 59 1/2 or over, there is no 10% penalty, in which case you can withdraw any of your converted funds tax- and penalty-free for any reason at all.
Readers, what’s your Roth conversion strategy?
Tomorrow: Ed Slott answers reader questions about IRA conversions and the dreaded alternative minimum tax, income limits for conversions and more.