Tips on converting your IRA to Roth

A change in IRA regulations eliminates the income restrictions for IRA conversions and will allow all individuals, regardless of income level, to convert their traditional IRAs to Roth IRAs beginning in 2010. A recent column on the changes prompted a torrent of questions from readers seeking more information and clarification on the new rules. Here are some of their questions and my answers.

Q Can the amount converted in 2010 be spread out over three years for tax purposes? As I understand, if I were to convert $300,000 in 2010 I would only need to include $100,000 in 2010, $100,000 in 2011, and the remaining $100,000 in 2012 in my income for those years.

A Not quite. According to Anne Ward, a senior adviser with Bloomington-based JNBA Financial Advisors, you have the choice of either paying taxes on the full amount in 2010, or paying no taxes in 2010 and paying taxes on half of the amount in 2011 and half in 2012. But you cannot divide the taxes over three years.

Q Are the taxes due in 2011 and 2012 based on the rate that is in effect in 2010 or does one pay the existing rate for 2011 and 2012?

A The tax rate you would pay would be based on your income in the years in which you're paying the taxes. In other words, you would pay the tax rate based on your income level in 2011 and 2012.

Q Can we contribute to our regular IRAs in January 2010 for 2010 and then convert that contribution (and past IRA contributions) in the same year in February 2010 to a Roth? 

A Yes, you can contribute to a traditional IRA and then convert that to a Roth in the same year.

Q I understand that you must hold onto the Roth for at least five years after the conversion before you can start withdrawing money that is earned in the Roth. Is that true for individuals over 59 1/2?

A According to Ward, "if you're older than 59 1/2, distributions can be taken without penalty from the Roth even if the five-year holding period isn't met."

Q Is there an age limit on converting to a Roth?

A There is no age limit. Converting after you retire can have some advantages. The investments in your Roth can continue to grow after the conversion and you can withdraw your funds tax-free. Converting to a Roth also means that you would not be required to begin taking withdrawals at age 70 1/2 as you are with a traditional IRA. According to Ward, converting to a Roth would also allow you to pass your IRA funds onto your children tax-free. "The account would be tax-sheltered for future growth and the children would not have to pay taxes when they withdraw the money." However, if you plan to pass the money on to a charity, it would be best not to convert your IRA to a Roth. "That wouldn't make any sense," adds Ward, "because the money would be passed to the charity tax-free whether it's a Roth or a traditional IRA."

Q Could converting to a Roth after age 65 have an effect on my Medicare coverage?

A According to Todd Grill of Entrust Midwest, "converting to a Roth may have an unexpected impact on their Medicare Part B premiums because the Social Security Administration looks at the modified adjusted gross income from the person's next year's tax return from the IRS to determine if the premiums get adjusted. So a person doing a Roth conversion in 2010 might see an increase in their premiums in 2011." Ward suggests that you find out what the income threshold is for your Medicare coverage and try not to exceed that level if you convert part of your IRA to a Roth.

Q I will be 70 1/2 in 2010 and required to take a minimum distribution from my IRA. If I understand Roth IRAs correctly, I cannot convert this distribution to a Roth.

A You are correct. You can't convert your required distribution to a Roth, but you can convert the balance of your traditional IRA to a Roth.

Q Can I convert the money in my 401(k) to a Roth in 2010, or does it have to be from a traditional IRA?

A "If you're still working for the same company, you can't withdraw your 401(k) and convert it to a Roth," says Ward. "But if you've left that company, you can convert your 401(k) to a Roth."

Q What happens if one spouse converts to a Roth but the other doesn't, and how is tax basis calculated for a midyear partial conversion?

A According to Ward, if you file jointly, you simply pay taxes on the amount you've converted to a Roth -- regardless of whether one spouse or both made the conversions. Regarding a midyear partial conversion, you would be taxed exactly the same no matter when during the year you converted IRA funds to a Roth.

Gene Walden is the author of more than 20 books on business and investing. He lives in the Twin Cities. Send questions or comments to gwalden100@comcast.net, or visit Allstarstocks.com.