By: Bruce Pietrantonio
You may have been thinking about your retirement and came to the realization that your Social Security Benefits alone will not provide the income necessary for you to maintain your standard of living in your retirement years. You took steps to remedy this situation by opening and funding a traditional IRA plan some time ago. You were entitled to take a tax deduction for the amount of your contribution but you will be taxed when you begin to take distributions from your IRA after you reach the age of 59 ½.
Roth IRA’s differ from traditional IRA’s as the contributions made to a Roth IRA are not deductible for tax purposes but the distributions taken from a Roth IRA are not taxable to the taxpayer. The dilemma: take the tax deduction now and pay taxes later or make non-deductible contributions now and pay no taxes later.
If you believe you may be better off with a Roth IRA as opposed to the traditional IRA that you have, you can convert your traditional IRA to a Roth IRA in 2010 regardless of income and spread the tax burden over the next two years under current tax law.
Converting your traditional IRA plan into a Roth IRA will cause a taxable event. The distribution from your traditional IRA will be taxed as ordinary income to the extent that your distribution exceeds your basis. You will be taxed at your effective tax rate. The 10% penalty for early distributions does not apply to conversions.
Under current tax law you can elect to pay all of the taxes on this distribution in 2010 or you can elect to spread the tax burden over two years, 2011 and 2012. You may report half the income from your distribution in 2011 and the other half in 2012. You will pay no taxes on this distribution in 2010 if you decide to spread the tax hit over the two years.
There are a few things to be aware of if you are planning to convert your traditional IRA. If you have multiple traditional IRA accounts that you want to convert, they must all be converted the same way. That is that you elect to pay all of the taxes in 2010 or you elect to pay the taxes over the two years 2011 and 2012. You may not elect to pay the tax in 2010 on one conversion while paying the taxes over two years on another conversion. All conversions must be done in the same manner. However, couples that each have a traditional IRA, may elect to treat their conversions using the two different rules. One spouse can elect to pay the tax upfront in 2010 while the other spouse can elect to defer the tax bill until 2011 and 2012.
Should you decide to cash in on the current very favorable Roth conversion rules for 2010 you may want to consider using separate Roth IRA’s for different asset classes. If one segment of your Roth IRA investments declines in value while other segments increase in value you can switch the non-performing account back to a traditional IRA tax and penalty free. You have until October 17, 2011, providing you filed your 2010 tax return timely, to un-convert your Roth conversion.
Bruce Pietrantonio owns BPA & Associates, LLC in Wauwatosa, WI. He concentrates his practice on tax and accounting work for individuals and small businesses. Bruce can be reached at 414-443-9680 or BPA6101@aol.com.
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