Help for Retirees Switching to Roth IRAs in 2010
An individual retirement account (IRA) is an investment account that provides owners with various tax benefits and incentives to save for the long-term goal of retirement. Roth IRAs and Traditional IRAs are two types of IRAs that provide different types of tax benefits to owners. In 2010, the IRS modified rules for converting from a Traditional IRA to a Roth IRA.
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Traditional IRA Vs. Roth IRA
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With a traditional IRA, your contributions are typically tax-deductible, and your earnings grow tax-deferred until distribution. A Roth IRA functions in a reverse manner, as contributions are not tax-deductible but distributions are typically tax-free. As a result, if you choose to convert your traditional IRA into a Roth IRA, you must pay ordinary income tax on the entire amount of the transfer. After the conversion, your contributions and earnings grow tax-free in the Roth IRA.
Modified Adjusted Gross Income Limits
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Historically, you could only convert a traditional IRA into a Roth IRA if your modified adjusted gross income for the tax year of the conversion was less than $100,000. Modified adjusted gross income, or MAGI, is essentially your adjusted gross income with certain items, such as deductions for IRA contributions or student loan interest added back in.
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Modifications for 2010
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Starting in tax year 2010, the IRS eliminated the MAGI limit for Roth conversions, meaning that any Traditional IRA holder could convert to a Roth IRA regardless of income. Additionally, IRA holders who convert in 2010 are allowed to report the amount of the conversion in 2011 and 2012, rather than having to report the entire amount in 2010. Essentially, this means you can spread out your tax liability rather than having to pay the entire tax in a single year.
Changing Your Mind
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If you change your mind about converting your Traditional IRA into a Roth IRA, the IRS allows you to recharacterize or "take back" your conversion if you follow certain rules. You must recharacterize the conversion no later than your tax filing date in the year of the conversion, and you must transfer any earnings on your Roth conversion back to your Traditional IRA as well. You must also report the recharacterization on your taxes using Form 8606.
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References
- IRS Publication 590: Roth Conversions
- Charles Schwab: 2010 Roth Conversion: Look Before You Leap
- Bankrate.com: 7 Steps to a 2010 Roth IRA Conversion
- MSN Money: Best Time to Convert to a Roth IRA
- IRS Publication 590: Recharacterizations
- IRS Publication 590: Converting From Any Traditional IRA to a Roth IRA
