As promised last week a discussion on why someone might choose to pay the entire tax bill in 2010 instead of deferring it to 2011 & 2012. Keep in mind that absent Congressional action, after 2010 the tax brackets above the 15% bracket will revert to their higher pre-2001 levels. That means the top four brackets will be 39.6%, 36%, 31%, and 28%, instead of the current top four brackets of 35%, 33%, 28%, and 25%. The Administration has proposed to increase taxes only for those making $250,000, but it is difficult to predict who will get hit by higher rates. So if you believe there’s a strong chance your tax rates will go up after 2010, you may want to consider paying the tax on the Roth rollover in 2010.
Here are some ways individuals can prepare now for the rollover opportunity.
(1) Non-high-income individuals who are able to make deductible IRA contributions for 2009 should do so. They’ll reduce their 2009 tax bill and, if they make the conversion to Roth IRA next year, they won’t have to pay back the tax savings until 2011 and 2012.
(2) Individuals who have never opened a traditional IRA because they weren’t able to make deductible contributions (and who never rolled over pre-tax dollars to a regular IRA) should consider opening such an IRA in 2009 and making the biggest allowable nondeductible contribution they can afford. If they convert the traditional IRA to a Roth IRA in 2010 they will have to include in gross income only that part of the amount converted that is attributable to income earned after the IRA was opened, presumably a small amount.
(3) Some high-income individuals may plan to make large conversions in 2010 but to opt out of the deferral of tax until 2011 and 2012 because they fear they will be in a higher tax bracket in those years than in 2010.
Your family’s entire financial situation should be discussed with your tax accountant before you take action to convert to a Roth IRA. There are many details that you should go over, such as whether the amounts you are thinking of switching to a Roth IRA are eligible for the rollover (technically, they are called “eligible rollover distributions”), whether you can make rollovers from your employer sponsored plan (for example, there are restrictions on rollovers from 401(k) plans), and the tax impact of rolling over amounts that represent nondeductible as well as deductible contributions.