Retirement Tax-Advantaged Planning: 2010’s Liberalized IRA-to-Roth-IRA Conversion
Retirement Tax-Advantaged Planning:
2010’s Liberalized IRA-to-Roth-IRA Conversion
Authored By: Jonathan D. Mishkin, LL.M.
Next year will be a pivotal one for retirement planning, as it will
be the fi rst year in which taxpayers will be eligible to convert
funds in regular IRAs (as well as qualifi ed plan funds such as
401(k)’s) to Roth IRAs regardless of such taxpayer’s income
level. In essence, Roth IRAs hold two major advantages over
1. Distributions from regular IRAs are typically taxed as ordinary
income. By contrast, Roth IRA distributions are tax-free if they
are “qualified distributions,” that is, if they are made: (i) after the
fi ve-tax-year period that commences with the fi rst tax year for
which the taxpayer made a contribution to a Roth IRA; and (ii)
when the account owner is 59 ½ years of age or older, or on account
of death, disability, or the purchase of a home by a qualified first
time homebuyer (limited to $10,000).
2. Regular IRAs are subject to the lifetime required minimum
distribution (“RMD”) rules that generally require minimum annual
distributions to be made commencing in the fi rst year following
the year in which the IRA owner attains age 70 ½. By contrast,
Roth IRAs are not subject to the lifetime RMD rules that apply to
regular IRAs (as well as individual account qualifi ed plans).
Should I convert – Things to Contemplate?
In most cases, the answer is yes. However, there are some
things to carefully consider prior to making a final decision.
1. Do You Have Adequate Funds to Pay the Income Taxes Due
Upon Conversion? Upon conversion of your regular IRA to a
Roth IRA, you pay tax on any earnings and pre-tax contributions.
This is in lieu of paying taxes upon subsequent withdrawals
from a Roth IRA account. However, you should not tap your
regular IRA to pay the income tax due upon conversion. If you
do so prior to attaining age 59 ½ you will owe an additional 10% penalty on that amount. Additionally,
you permanently relinquish the opportunity for tax-free compounding of that amount.
A. You cannot avoid this “conversion tax” by simply rolling over an amount equal to your aftertax
(non-deductible) contributions. Each dollar you roll over from a regular IRA is considered a
“blended” dollar. Therefore, a percentage of the amount rolled over into the Roth IRA account will
be taxed regardless (except in the unlikely event that your IRAs are worth less than the amount of
your after-tax contributions).
2. Will the Rollover Disqualify You for Important Tax Benefits? The conversion income could push
you into a higher tax bracket and disqualify you from other tax benefi ts such as the dependent child
and college tuition tax credits, student loan interest deductions, etc.
3. How Much Time Do You Have Until Retirement? Generally, the older you are, the less sense it
makes to convert a regular IRA to a Roth IRA because you will have less time to make up for what
you lost in taxes upon conversion.
4. Do You Plan to Leave Your IRA to Your Heirs? One scenario in which it makes sense for an
older regular IRA holder to transfer funds to a Roth IRA is when he or she does it for estate planning
purposes. Unlike traditional IRAs, Roth IRAs require no minimum withdrawals during the IRA
owner’s life. If the surviving spouse inherits the Roth IRA account, he or she is not required to take
any minimum withdrawals. With a regular IRA, you are mandated to begin taking taxable withdrawals
no later than the year after you turn 70 ½. Therefore, you lose out on the chance for that sum
of money to continue compounding without paying taxes. In addition, conversion to a Roth IRA
will reduce your taxable estate by the amount of income tax you pay upon conversion. This can
significantly reduce estate/Oregon inheritance tax exposure for your heirs.
5. Will Your Income Tax Bracket Drop After Retirement? The clearest case in which converting
from a regular IRA to a Roth IRA does not make sense is when you expect to drop into a much lower
income tax bracket after retirement (say, from 25% to 15%). Why? You will have to pay income
tax on the conversion at your current high rate. Instead, let the money compound in your regular
IRA and pay taxes at your lower rate in retirement. However, if your tax rate is only expected to
drop a few points after retirement (say, from 28% to 25%), conversion is probably still the preferred
Complicating Factor for 2010 Conversions
As aforementioned, a unique income tax rule will apply for IRA to Roth IRA conversions occurring
during the 2010 tax year. Unless a taxpayer elects otherwise, none of the gross income
resulting from the conversion is included in income in 2010. One-half of the income resulting from
conversion will be includible in 2011, and the remaining half in 2012.
What to do in 2009 in Anticipation of Conversion
Taxpayers who intend to take advantage of the new conversion option next year should
consider implementation of the following strategies:
• Taxpayers who are eligible to make deductible IRA contributions
this year should do so. You will reduce your 2009 tax bill and, if you make
the conversion to a Roth IRA next year, you will not have to remit the tax
savings until 2011 and 2012.
• High-income taxpayers should consider making non-deductible
IRA contributions this year. You can then roll over the
accounts into Roth IRAs next year without any tax cost.
• While some high-income taxpayers plan to make large
conversions in 2010, they plan to opt out of the ability to defer
tax until 2011-2012 due to concerns that they will be in a higher
tax bracket at that time. In such a circumstance, taxpayers
should avoid the standard year-end planning wisdom of accelerating
deductions and deferring income, but should, rather, do
the reverse in an effort to avoid being pushed into the highest
brackets by a large IRA to Roth IRA conversion. These taxpayers
should be considering alternatives to defer deductions in
2010, and accelerate income from next year into 2009.
Although all taxpayers are eligible to convert regular IRAs and
qualified plan funds to a Roth IRA during the 2010 tax year,
such blanket eligibility does not necessarily make it a good idea.
However, in almost every circumstance, conversion for at least
estate planning purposes will add value through minimization
of federal/Oregon inheritance tax. If you have any questions,
or are interested in exploring whether a Roth IRA conversion
makes sense in your particular tax and/or estate planning situation,
please contact Randall L. Duncan or Jonathan D. Mishkin,
LL.M. at (503) 242-0000, and we will be glad to assist you.
Randall L. Duncan
Direct Line: 503-417-6010
Jonathan D. Mishkin, LL.M.
Direct Line: 503-417-6007
360 East 10th Avenue, Suite 300, Eugene, OR 97401-3273
1001 SW Fifth Avenue, 16th Floor, Portland, OR 97204-1116
333 High Street, NE, Suite 200, Salem, OR 97301-3632
Nothing in this communication creates or is intended to create an
attorney-client relationship with you, constitutes the provision of legal
advice, or creates any legal duty to you. If you are seeking legal advice,
you should fi rst contact a member of the Closely Held Business
Team with the understanding that any attorney-client relationship
would be subsequently established by a specific written agreement
with Harrang Long Gary Rudnick P.C. To maintain confi dentiality,
you should not forward any unsolicited information you deem to
be confi dential until after an attorney-client relationship has been
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