Friday, August 5, 2011

Roth IRAs – Market Sell-offs Prompt Two Vital Questions

The planning topic du jour in 2010 involved converting traditional IRAs to Roth IRAs, capitalizing on favorable tax laws effective in 2010 and depressed market values. Despite all the press and attention devoted to the issue in 2010, very little discussion touched on the importance of 2011.

Recharacterization Opportunity – Must be on or before 10/17/11!
Roth IRA conversions can be viewed as a short-term,“heads you win, tails you tie” wager. Specifically, 2010 conversions can be recharacterized back to a traditional IRA for any reason, as long as the recharacterization occurs on or before 10/17/11.  This is the extended due date for 2010 returns; however, you have until this date even if you did not extend your return or have already filed.

As an example, assume you converted a $50,000 IRA to a Roth in December 2010, and it is now worth $30,000 because of market declines. If you do not recharacterize the conversion, your 2010 return will report ordinary income of $50,000. Unique rules in 2010 allowed you to report this income all in 2010 or half ($25,000) in 2011 and half ($25,000) in 2012,deferring the tax hit. With recent market declines, you may wish to recharacterize the conversion now.

Note: If you do recharacterize some or all of a 2010 conversion, you may still re-convert that money back to a Roth in 2011. However, you must wait at least 30 days to convert the same amounts. In addition, 2011 conversions may not be spread over future years. In other words, you will have to report all of the income resulting from the conversion in 2011. Of course, you now have until October 15, 2012, to determine whether the 2011 conversion worked well or whether to recharacterize again.

2011 Conversion – Must be on or before 12/31/11!
Starting in 2010, anyone could convert to a Roth IRA, regardless of filing status or income level. That opportunity continues in 2011 (and all future years). The only unique feature about 2010 conversions involved the option to defer income into 2011 and 2012. The extension of the Bush Tax Cuts,  coupled with declining market values, make 2011 Roth conversions worthy of discussion. Also, as discussed above, 2011 conversions offer the same “heads you win, tails you tie” feature via the recharacterization rules.

What to do?
Whether you converted in 2010 or are considering a 2011 conversion, please contact us tax benefits and choices you have.