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.
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.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
When do you have to pay the tax bill?
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.
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.
-
Original Medicare vs Medicare Advantage Quiz: Which is Right for You?Quiz Take this quick quiz to discover your "Medicare Personality Type" and learn whether you are a Traditionalist, or a Bundler.
-
Ask the Editor: Capital Gains and Tax PlanningAsk the Editor In this week's Ask the Editor Q&A, Joy Taylor answers questions on capital gains tax rates and end-of-year tax planning
-
Time Is Running Out to Make the Best Tax Moves for 2025Don't wait until January — investors, including those with a high net worth, can snag big tax savings for 2025 (and 2026) with these strategies.
-
Getting Out of an RMD Penaltyretirement When your brokerage firm miscalculates your required minimum distributions, you have recourse.
-
Borrowers Get More Time to Repay 401(k) Loans
retirement If you leave your job while you have an outstanding 401(k) loan, Uncle Sam now gives you extra time to repay it -- thanks to the new tax law.
-
It’s Not Too Late to Boost Retirement Savings for 2018
retirement Some retirement accounts will accept contributions for 2018 up until the April tax deadline.
-
How to Correct a Mistake on Your RMDs from IRAsretirement If you didn't take out the correct required minimum distribution because your brokerage firm made a mistake, the IRS may show some leniency.
-
Ways to Spend Your Flexible Spending Account Money by March 15 Deadline
spending Many workers will be hitting the drugstore in the next few days to use up leftover flexible spending account money from 2018 so they don’t lose it.
-
Making the Most of a Health Savings Account Once You Turn Age 65
Making Your Money Last You’ll face a stiff penalty and taxes if you tap your health savings account for non-medical expenses before the age of 65. After that, the rules change.
-
Reporting Charitable IRA Distributions on Tax Returns Can Be Confusing
IRAs Taxpayers need to be careful when reporting charitable gifts from their IRA on their tax returns, or they may end up overpaying Uncle Sam.
-
When You Can Expect to Receive Your Tax Refund
taxes The quickest way to receive your tax refund is to file electronically and have the money directly deposited into your bank account.
