Beginning in 2010, any taxpayer may convert a traditional IRA to a Roth IRA regardless of income level. Current law limits the availability of such a conversion to taxpayers with adjusted gross income under $100,000. For IRA to Roth IRA conversions occurring after 2010, the income resulting from the conversion is included on the return for the tax year in which the funds were transferred, withdrawn, or considered withdrawn from the traditional IRA. However, for conversions occurring in 2010, unless the taxpayer elects otherwise, no income from an IRA to Roth IRA conversion is included in the taxpayer's 2010 taxable income. Rather, one-half of the income is included in the taxpayer's 2011 income and the other half is included in the taxpayer's 2012 income. The 10% additional tax on distributions from an IRA prior to the taxpayer turning 59½ does not apply to traditional IRA to Roth IRA conversions.
A conversion of an individual's traditional IRA can be made without the individual actually taking a distribution. An amount in a traditional IRA may be converted to an amount in a Roth IRA by any of the following three methods:
- the amount may be distributed from a traditional IRA and contributed (rolled-over) to a Roth IRA within 60 days after the distribution.
- the amount may be transferred from a non-Roth IRA at one financial institution in a trustee-to-trustee transfer to a Roth IRA at another financial institution.
- the amount may be transferred from a traditional IRA to a Roth IRA at the same financial institution (in this case, a physical transfer of assets is not necessary, but the instrument governing the traditional IRA must be replaced by a Roth IRA instrument).
For tax reporting purposes, any conversion from a traditional IRA to a Roth IRA (no matter how effected) is treated as a distribution from the traditional IRA and a qualified rollover contribution to the Roth IRA. Thus, amounts converted from a traditional IRA to a Roth IRA are treated as distributions for which a Form 1099-R must be filed by the trustee maintaining the traditional IRA and must be reported by the owner of the IRA on Form 8606. The amounts received by the trustee of the Roth IRA must be reported by the trustee on Form 5498, in box 3.
Converting a traditional IRA to a Roth IRA may be particularly advantageous to individuals:
- who expect to be in a higher tax bracket during retirement (perhaps due to future tax rate increases). Sheltering future income by placing funds in a Roth IRA (and currently paying the tax on those funds) makes less sense if the funds will be withdrawn when the individual is in a lower tax bracket.
- whose traditional IRAs contain predominantly after-tax amounts.
- who want to avoid (a) the lifetime required minimum distribution rules and (b) the incidental death benefit requirements, both of which apply to traditional IRAs, but not Roth IRAs. Avoiding the lifetime required minimum distribution rules allows tax-free earnings to continue to accumulate for the ultimate benefit of the Roth-IRA owner's heirs. Also, unlike earnings and deductible contributions in a traditional IRA, amounts received by Roth IRA beneficiaries won't have to be included in the beneficiaries' income, because only taxable income (e.g., as in traditional IRAs) in the beneficiaries' hands is income in respect of a decedent.
If you have any questions regarding this e-Alert, please contact
Colin Murchison at 817.334.7219 or cmurchison@jw.com or any other JW Wealth Planning attorney.
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