If you thought about a Roth conversion early this year, it’s time to think about it again. Conditions have changed and you might want to reverse course and rushing to convert or perhaps to reverse a conversion that now seems unprofitable.
To rewind, the process involves moving assets from a traditional IRA to a Roth IRA. In a traditional IRA, or TIRA, you may or may not get a tax deduction on contributions, but investment gains are tax-deferred until withdrawal. At that point, gains and any previously untaxed contributions are taxed as ordinary income.
Roths offer no upfront deduction, but all contributions and investment gains are tax free when withdrawn. They offer other benefits as well, such as no minimum withdrawal requirement after age 70½ and better deals for heirs.
Upon converting, the investor pays income tax as with any TIRA withdrawal, but is not subject to the 10% early withdrawal penalty that otherwise applies when money is taken out before age 59½. Generally, a conversion makes sense if you expect to be in a higher income tax bracket in retirement than in the year of the conversion. By converting, you could pay the tax now to avoid a higher tax later.
Before 2010, conversions were available only to singles and couples with incomes below $100,000. That limit has been removed permanently, but there is a temporary tax benefit for conversions done in 2010: The investor can opt to split the tax bill between 2011 and 2012, or to pay it all in 2010. If you postpone the tax, you’ll pay at whatever rate is in effect in 2011 and 2012.