Advertisement
Taxes

The New Roth Rollover Rules Explained

Kimberly Lankford answers readers' questions about the new rules that take effect in 2010.

I've been getting a ton of questions from readers about the new Roth IRA rollover rules that take effect in 2010, when anyone will be able to convert their traditional IRA to a Roth regardless of their income. (You can make the switch now only if your adjusted gross income is less than $100,000, whether married or single.) To help you understand how the new rules work, here are the answers to several key questions I've received.

Advertisement - Article continues below

How do you calculate how much money will be taxed when you make the conversion?

The calculation is easy if you've made only tax-deductible contributions. In that case, you'll have to pay taxes on the entire balance when you convert a traditional IRA to a Roth IRA. But the money can grow tax-free after that (see Why You Need a Roth IRA for details). If you've made both tax-deductible and nondeductible contributions to your traditional IRAs, then your tax bill will be based on the ratio of nondeductible contributions to the total balance in all of your traditional IRAs. If your total balance is $100,000, for example, of which $20,000 represents nondeductible contributions, then 20% of any conversion would be tax-free.

When do you have to pay the tax bill?

Advertisement
Advertisement - Article continues below

If you convert your traditional IRA to a Roth in 2010, you can spread the tax bill over two years. You report the first half of the conversion on your 2011 tax return (which you file in April 2012) and the balance on your 2012 return. If you're moving a large amount of money, however, you may want to start making quarterly estimated tax payments in 2011 to avoid an underpayment penalty.

Advertisement - Article continues below

The income limit for Roth IRA conversions is permanently eliminated, but the special opportunity to spread the tax bill over two years applies only to conversions made in 2010.

It's worthwhile to make the switch only if you don't have to tap the IRA for cash to pay the taxes. So even though you have a while before the taxes are due on the conversion, you may want to start setting aside some money over the next year or so to cover the tax bill.

What happens if you convert the traditional IRA to a Roth but then discover you don't have enough money to pay the tax bill? Or what if the account goes down in value after you make the switch?

You'll get a chance to change your mind. If you roll over your traditional IRA to a Roth in 2010, then you'll have until October 15, 2011, to "recharacterize" your conversion and switch the account back to a traditional IRA. You can then reconvert the traditional IRA to a Roth later -- you must wait at least 30 days and until the next calendar year to convert it again. You may end up with a smaller tax bill if your account value has shrunk since your original conversion. For more information, see Undoing a Roth Conversion.

Do you need to have earned income to convert a traditional IRA to a Roth?

No. Although you need earned income to contribute to an IRA, you don't need it to convert a traditional IRA to a Roth.

Advertisement
Advertisement

Most Popular

11 Dividend-Paying Stocks You Should Think Twice About
dividend stocks

11 Dividend-Paying Stocks You Should Think Twice About

Dividend-paying stocks often can be a store of safety, but 2020 has been difficult on income equities. These 11 picks look like shaky plays despite th…
September 21, 2020
Medicare Basics: 11 Things You Need to Know
Medicare

Medicare Basics: 11 Things You Need to Know

There's Medicare Part A, Part B, Part D, medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare --…
September 16, 2020
Where You Should Invest Now
investing

Where You Should Invest Now

Kiplinger.com senior investing editor Kyle Woodley joins our Your Money's Worth podcast to answer investor questions about tech stocks, the election a…
September 22, 2020

Recommended

How To Buy a Roth IRA When You Make Too Much To Qualify For One
Roth IRAs

How To Buy a Roth IRA When You Make Too Much To Qualify For One

With their tax-free growth and tax-free withdrawals, Roth IRAs are a great deal — if you qualify. If you don’t, well, there’s still a way to get into …
September 23, 2020
The Annuity With a Tax-Planning Twist
Financial Planning

The Annuity With a Tax-Planning Twist

A qualified life annuity contract helps retirees with guaranteed payments to last their entire lives.
September 21, 2020
HSA Limits and Minimums
health savings accounts

HSA Limits and Minimums

Annually adjusted contribution limits and other requirements must be met if you're covering health care costs with a Health Savings Account.
September 21, 2020
Don’t Be Paralyzed by Uncertainty
retirement planning

Don’t Be Paralyzed by Uncertainty

You definitely need a plan, because what’s ahead could be scarier than what’s behind us.
September 21, 2020