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Time Running Out to do a Roth IRA Conversion in 2010

Updated on March 3, 2013

Should You Do a Roth IRA Conversion in 2010?

As we reach the end of 2010, countless people have already completed Roth IRA conversions, and many others are wanting to know if a Roth IRA conversion in 2010 is the best move for them.

Why are Roth IRAs in the news so much this year? Before 2010, only people with modified adjusted gross incomes of less than $100,000 were allowed to convert. Starting in 2010, this income restriction has been removed, meaning most people are eligible to convert their traditional IRAs to Roth IRAs.

In addition to the income limitation being removed, the IRS is allowing taxpayers who convert in 2010 to spread their taxes out over two years. So instead of having to pay it all on your 2010 tax return, you can pay half in 2011 and half in 2012.

IRA and Roth IRA Basics You Should Know

While the new regulations may appear too good to pass up, make sure you research your situation carefully before jumping into a Roth IRA conversion in 2010. Just because you can convert to a Roth doesn't mean you should do a conversion, at least not right away.

Here are some IRA and Roth IRA basics you should be aware of before you determine if a Roth IRA conversion is right for you.

Traditional IRAs

- Contributions into traditional IRAs are tax deductible, reducing your taxable income for that year.

- Withdrawals from traditional IRAs are taxed at your ordinary income tax rate, so if you are in the 15% tax bracket you'll pay 15% on the amount withdrawn, if you're in the 28% tax bracket you'll pay 28% on any distributions, etc.

- The IRS requires you to take a minimum amount out (based on your age and the account balance) after age 70 1/2.

Roth IRAs

- Contributions to a Roth IRA are not tax deductible.

- You may not be allowed to contribute to a Roth IRA if your income is above the limits.

- Qualified withdrawals (must be at least age 59 1/2 and have had the Roth for at least five years) are not subject to income tax.

- Roth IRAs are not subject to the required minimum distribution rule that traditional IRAs are.

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Roth IRA Contribution Limits

There's still time to do a Roth IRA contribution for 2011. Below are the Roth IRA limits for 2011 and 2012:

Roth IRA Contribution Limits 2011

Under age 50: $5,000

Age 50 or over: $6,000

Roth IRA Contribution Limits 2012

Under age 50: $5,000

Age 50 or over: $6,000

Who Should Consider Converting to a Roth

As you can see, there are positives and negatives to both types of IRAs, so how do you know which one is right for you? Here are some general guidelines to help you determine whether a traditional or Roth IRA makes the most sense for you:

- Roth IRAs are more beneficial if you expect to be in a higher tax bracket when you retire (or when you'll need the money).

- If you think you will be in a lower tax bracket when you retire, then a traditional IRA may make more sense as you'll get a tax break up front when your tax rate is higher.

roth ira
roth ira

Is a Roth Conversion Right For You?

Because of the tax advantages of Roth IRAs, when you convert a traditional IRA to a Roth IRA, you have to pay taxes on the entire amount converted. This can be a substantial tax bill depending on how much you convert and what tax bracket you are in.

Even with the higher taxes that usually result from converting to a Roth IRA, it's still a good strategy for some people. A Roth IRA conversion may be beneficial to you if: You should consider converting to a Roth IRA if:

- You expect to be in the same or higher tax bracket when you retire (or when you will need the funds),

- You won't need the money you convert for five years or more, and

- You can afford to pay the taxes on the conversion without dipping into your retirement savings.

What if You Want to Undo a Roth Conversion?

If you converted a traditional IRA to a Roth and are unhappy with that decision, there's still time for a do-over… but not much!

Roth IRA conversions can be recharacterized back to a traditional IRA, but only for a certain period of time. In general you can recharacterize a contribution or conversion any time up to your tax deadline, including extensions for the tax year in which you converted. For example, if you did a Roth IRA conversion in July 2010, you have until October 15, 2011 to reverse that conversion.

So what is a Roth IRA recharacterization?

Basically, a recharacterization is when you reverse an IRA contribution or a Roth IRA conversion, and can be done for various reasons. Some examples where you might want to recharacterize a contribution or a conversion include:

Contributions: You may have contributed to a Roth IRA early in the year, only to discover later that your income was too high to contribute to a Roth. Or you may have earned less than you though you would, and now are able to deduct contributions to traditional IRAs.

Conversions: The most common reason to recharacterize a conversion is when the stock market falls after you do a conversion; the purpose of the recharacterization is to reduce your tax bill that resulted from the original conversion. Or you may just decide that a Roth IRA wasn't the best tax strategy for you after all… there are many reasons to undo a Roth IRA conversion.

How can a recharacterization lower your tax bill?

Continue Reading What if You Want to Undo a Roth IRA Conversion?

Not Just for 2010

While Roth IRA conversions won't be right for everyone, some people will benefit from the new 2010 conversion rules. The people who will benefit the most include people who have been unable to contribute to Roth IRAs due to income limits and people who expect to be in a higher tax bracket when they retire (or who are convinced that tax rates will continue to go up regardless of which bracket you are in).

It's important to note that just because you can convert to a Roth IRA doesn't mean you should convert to one. You should consult with a financial or tax professional to determine if a Roth IRA conversion is right for you, since every situation is different. Furthermore, you should evaluate your situation every year as tax rules change each year. A Roth conversion in 2010 might not make sense for you, but a conversion in future years could make sense if tax laws change or your situation changes.

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