2010 Roth Conversion

The IRS is having a sale!

Starting in 2010, and in every year after that, anyone willing to pay the income tax cost may convert all or part of their traditional pre-tax IRA’s to a Roth IRA. You will no longer be precluded from doing this if your modified Adjusted Gross Income exceeds $100,000 as is currently the case. And to kick off this new opportunity, they’re having a one-time sale on Roth-ification. A grand opening sale, if you will.

Here’s the deal. Let’s say you have a $500,000 traditional IRA, and you’d like to convert $200,000 of it to a Roth IRA. If you do that in 2009 or 2011 or later, the normal rules apply; normally, you would add that $200,000 to your taxable income in the year of the conversion and pay tax on it at your tax bracket for that year. More likely, with such a large amount of additional income you would end up crossing tax brackets and paying tax at some blended rate.

But in 2010, you can take advantage of the IRS’s one-time sale. Instead of adding $200,000 to your 2010 income, you have the option of splitting it in half and adding half to your 2011 income and half to your 2012 income.

What a deal! There’s two potential benefits to be gained here. First, there’s delay. You get to delay tax payment, which is always worth something. You can set aside the tax dollars you’ll owe, put them in a money market fund, and collect the interest for a while. The IRS is in effect giving you an interest-free loan for a year or two.

But wait. There’s more. Second, by spreading the taxable income—$200,000 in our example—over two years, you might reduce the portion of it that’s kicked up into a higher tax bracket and thereby actually reduce your overall tax bill. It’s Christmas in July! (Or April, actually.)

What about state tax? That depends on how your state figures its income tax. Many states, like New York and Georgia for instance, start their tax calculations with your federal Adjusted Gross Income and then fiddle around from there. In these states you’ll end up getting a similar state tax break, because your $200,000 will be split between your 2011 and 2012 federal Adjusted Gross Income. Unless your state legislature decides this particular situation ought to be handled differently.

So if you’ve concluded that Roth-ification of all or part of your IRA is a good idea for you, then doing it in 2010 might indeed be a very good idea.

Act now (actually next year). This offer won’t be repeated. Operators are standing by.