Roth IRA Conversions

Posted on September 15, 2011

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If you switched an IRA to a Roth in 2010, note this tax-saving opportunity:  You have until Oct. 17, 2011 to undo the switch and recover the tax paid.  If the balance in your Roth has fallen since the conversion…a reasonable possibility in light of the recent decline in the stock market…switching the funds back to an IRA can save you a lot of tax. By returning the money to the IRA, you eliminate the tax on the conversion. If you’ve already filed for 2010, use Form 1040X to recoup the tax. You then must wait 30 days before you are able to reconvert the funds to a Roth.  At that time, reconverting the smaller balance to a Roth will produce a lower tax bill.

If the stock market drop has you thinking about a Roth conversion now… Consider using separate Roth IRAs for different asset classes. That way, if one segment of your Roth investments drops in value while the others increase, you can switch the underperforming account back to an IRA tax and penalty free. This strategy gives you maximum flexibility. If you timely file your 2011 return, you will have until Oct. 15, 2012 to decide whether you are better off unconverting.  Note that the old $100,000 adjusted gross income cap on conversions is no more, and the option to defer the tax bill on the switch over two tax years ended after 2010.

Seniors who are thinking of converting should note a couple of tax traps:  The extra income from the conversion can affect Medicare Part B premiums.  Upper incomers have to pay a monthly surcharge on top of their regular premium.  The surtax starts above $85,000 of AGI for singles and $170,000 for married filers, rising to 220% of the basic premium for single filers with income above $214,000 and married couples with AGI over $428,000. Roth conversion income is included in computing AGI for the surcharge. That can cause Part B premiums to increase by up to $3,000 a year per person. So reporting a lot of Roth conversion income in 2011 may end up dramatically increasing your Medicare Part B premium for 2013.

There’s a similar effect with Social Security benefits. Lower-income seniors
who convert may see more of their benefits taxed because of that additional income.  But seniors won’t have to take required minimum payouts from their Roths.  And any payouts they take will be tax free. That will trim their AGI in future years.

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