Converting IRA to Roth IRA

[MannyLNJ]

I have some investments in an IRA that was originally a 401K. One of these investments is a stock that had been stagnant but some people believe will blow the roof off very soon. These people tell me to convert the portion of the IRA to a Roth IRA.

 

What are the advantages/disadvantages?

 

I'm 35 the amount in question is around 12K and I make between 40 and 45K a year

[bullthistle]

You will be taxed on the IRA if you switch but won't be taxed once you withdraw from the Roth at 59 1/2. So if you have a lot of writing off to do in 2010 it might be the time to switch but then it all depends on your tax rate. If you use turbo tax you could experiment this year by adding what your IRA is presently and see what the difference is so you have some insight on the tax hit.

[Kevin20]

Pretty straightforward,

Advantage: withdrawals are tax free in retirement.

Disadvantage: All the dollars you convert to Roth count as taxable income for 2010.

 

More specifically, each of those converted dollars will be taxed at your marginal rate. Don't know your filing status, but if you were single and didn't have extraordinary deductions, then the conversion "income" would place you solidly in the 25% tax bracket, meaning you'd owe an extra $3000 on your taxes as a result of converting $12K (for 2010, which you file next year).

 

You can't know for sure, but it may well be worthwhile to do that if you can withhold extra money this year and handle the the tax hit.

 

BTW, I'd make the decision without regard to whether you think that particular stock will do well or not. It's prudent to make the decision based on general IRA-to-Roth conversion implications, not on the hope that you're about to hit a home run on one stock -- which could go wrong. E.g., you may convert and then your stock collapses to zero. You'd still owe your $3000 in tax, but with nothing to show for it.

[MannyLNJ]

I heard if I convert in 2010 I can spread the tax over two years. I don't have much write offs since I don't have a home or major student loans. If this long shot pays off I would want to use the money to go back to school and get a degree.

[Kevin20]

I heard if I convert in 2010 I can spread the tax over two years. I don't have much write offs since I don't have a home or major student loans. If this long shot pays off I would want to use the money to go back to school and get a degree.

 

 

Yes that's right, sorry I forgot. In fact, you even get to delay a year before getting taxed:

 

 

http://articles.moneycentral.msn.com/Retir...a-roth-ira.aspx

Prior to 2010, the amount converted would be reported as income on that year's tax return. Under TIPRA, however, conversions done in 2010 don't have to be reported on your 2010 tax return. Instead, you get to report the income on your 2011 and 2012 tax returns, said Barry C. Picker, a certified public accountant and financial planner with Picker, Weinberg & Auerbach, CPAs, and the author of "Barry Picker's Guide to Retirement Distribution Planning."

 

Thus, if you converted a $100,000 IRA in 2010, you would report $50,000 in ordinary income in 2011 and $50,000 in 2012. In the parlance of advisers, you get to split the income.

 

If you do a Roth IRA conversion in 2011 or later, you don't get to spread the income or tax bill over two years. And that's why folks in the industry are salivating over this one-year-only bargain.

Edited February 9, 2010 by Kevin20