Income Limit for Roth IRA Conversions Eliminated Beginning in 2010

Income Limit for Roth IRA Conversions Eliminated Beginning in 2010
From the Riker Danzig December 2009 Tax and Trusts & Estates UPDATE

Effective January 1, 2010, and going forward, the restriction that prevented individuals with modified adjusted gross income exceeding $100,000 from converting a traditional IRA, or other qualified retirement plan, to a Roth IRA will be eliminated. A Roth IRA contains assets on which federal income tax has been paid, and those assets may grow and be distributed income-tax free. The conversion will be permissible for any taxpayer, although if you are older than 70 ½, you must still withdraw your minimum required distribution for the year in which you decide to convert.

There are many factors to consider when deciding whether or not to convert your traditional IRA to a Roth IRA. Most significantly, conversion will accelerate the reporting of the previously untaxed IRA funds as income. A special rule applies in the year 2010 that will allow you to choose whether to report the resulting income entirely in 2010 or spread it out over the following two years (i.e., equally in 2011 and 2012). Once the income tax acceleration occurs, the funds can grow in the tax-sheltered Roth IRA, and future distributions from the Roth IRA will be tax-free as long as they are made: (a) after you have attained age 59 ½ years, became disabled, or died; and (b) more than five years after you have made a contribution or conversion to a Roth IRA. If you take a distribution from your Roth IRA that doesn't meet one or both of these requirements, the distribution may be subject to income tax and/or a 10% penalty.

Further, the minimum distribution rules that apply to traditional IRAs and require taxpayers to begin withdrawing IRA funds (and pay the resulting income taxes) at age 70 ½ do not apply to Roth IRAs. You are not required to take any distributions from the Roth IRA during your lifetime. After death, however, a Roth IRA is generally distributed under the same rules as a traditional IRA. That is, the funds may be distributed over a designated beneficiary's lifetime (so-called "stretch treatment"), or, if there is no designated beneficiary, over a five-year period beginning with the IRA owner's death.

To elect conversion, you may either have your current IRA administrator transfer the account into a Roth IRA directly, or you may withdraw the funds from your IRA and contribute them to a Roth IRA within 60 days. Because of the potential pitfalls with the second method, taxpayers might be better advised to opt for the direct account-to-account transfer.