2010 Roth IRA Conversions: Complexity Requires Professional Attention
By: Dr. Gene Henssler
The Henssler Financial Group Position Paper

Next year, more than 10 million middle- and high-income investors will have access to one of the most flexible retirement vehicles utilized today—Roth IRAs. While income limits will still apply to regular Roth contributions made next year, the income restrictions on Roth IRA conversions (currently $100,000) will be lifted on January 1, 2010. This is thanks to a little-publicized provision in the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005.

TIPRA provides a window of opportunity for investors, who have not been able to take advantage of Roth IRAs in the past to convert traditional IRA assets to Roth IRAs. If you are able to pay the tax liability that will be due as a result of a conversion from a source outside the IRA, then you should consider the following information.

While there are definite tax and estate planning advantages to converting, this is a complicated topic that requires professional attention. Unfortunately, there is no "one size fits all" answer to the question of whether converting assets in a traditional IRA to a Roth IRA makes sense. Each person's circumstance is different. Keep in mind that since deductible IRA contributions are made with pre-tax dollars, you must pay the taxes up-front to convert to a Roth IRA. If you are able to pay the tax liability that will be due as a result of a conversion from a source outside the IRA, you should consider the following information.

The Basics:

A Roth IRA is a retirement account in which contributions and earnings grow tax-free. Contributions, which can be made at any time, are not tax-deductible, as they are made with after-tax earned income. After a Roth IRA has been in existence for five years, distributions are exempt from income tax if you take them after attaining age 59½, death or disability occurs, or to pay first-time homebuyer expenses (up to a lifetime limit of $10,000). In contrast, distributions from a Traditional IRA may be fully taxable at ordinary income rates. Today’s rates can be as high as 35%.

Why Pay the Tax Now?

With a few exceptions, our Tax Consultants generally advise clients to delay paying income tax for as long as possible. Converting to a Roth seems contradictory, as you will have to pay tax on the money you convert. So why then are we suggesting you consider paying the tax now?

• Your retirement plan assets are likely at the lowest levels in many years, which could result in potentially paying a lower tax bill prior to the recovery of the account.
• If your AGI is too high to participate in a Roth IRA, this is a good time to create a mix of retirement accounts effectively providing “tax diversification” in retirement. A mix of accounts can give flexibility for the future by providing tax deferred and tax free sources of retirement income.
• If you are concerned that income tax rates will escalate as a result of underfunded future liabilities, such as Medicare and Social Security, then converting now lets you lock in what are considered to be historically low rates and avoid higher taxes later.
• For conversions occurring in 2010, you can spread your tax liability across the 2011 and 2012 tax years. Note: After 2010, you will have to pay all the tax in the same year.

For those who want hard numbers, the following chart shows the amount of tax avoided, when $10,000 was invested in some well-known stocks 40 years ago.

Stock	$10K Invested in 1968 Is Now Worth	Potential Tax Avoided
Hewlett-Packard (NYSE: HPQ)	$1,409,697	$493,394
Boeing (NYSE: BA)	$912,556	$319,395
Coca-Cola (NYSE: KO)	$1,063,704	$372,296
Alcoa (NYSE: AA)	$472,386	$165,335

Source: Yahoo! Finance. Tax avoided is based on current maximum 35% rate that applies to traditional IRA and 401(k) distributions

Imagine what another 50 years would do to those values. With the potential for huge tax savings that Roth conversions make possible, high-income taxpayers should consider converting in 2010.

Estate Planning Tool:

Beyond the tax advantages, perhaps the most compelling reason to convert is that, unlike traditional IRAs, Roth IRAs do not force you to take distributions. Put simply, if you don't need the money, you can leave it in your account to grow.

From an estate planning standpoint, a surviving spouse can take distributions tax free or continue to allow the account to grow, and upon their death, pass the account on to their beneficiaries income tax free. Roth IRA accounts are included in the deceased estate, therefore, they are subject to estate taxes if the taxable estate is more than $3,500,000 for 2009. Beneficiaries must take distributions in accordance with IRS rules.

Conversion Considerations:

Conversion of Traditional IRAs to a Roth IRA can be a little tricky and can result in unexpected tax liabilities, if not properly planned. This is especially true if you have a combination of deductible and non-deductible Traditional IRAs or Rollover IRAs. The IRS requires that all IRAs be considered in the conversion process. The IRS will not let you “cherry pick” only the non-deductible contributions, but rather you must calculate a pro rata ratio against all your IRAs to determine the non taxable basis amount.

Strategy 1: If you have assets in a former employer's 401(k), it is probably better to leave it there until after you complete the Roth conversion so those assets do not affect the ratio. Additionally, if your employer has a qualified plan that will accept rollovers from IRAs, you may be able to move assets from your IRA into the plan, and ultimately reduce the current tax burden from a Roth conversion. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) modified previous rules regarding rollover contributions to qualified plans. Prior to 2002, the only rollover contributions that could be received by a qualified plan were eligible rollover distributions from another qualified plan or distributions from a Conduit IRA. EGTRRA amended the rules to allow rollovers from IRAs to qualified plans but only to the extent it would be includible in gross income if it were not rolled over. Traditional IRAs, including SEP-IRAs and SIMPLE IRAs, all qualify for treatment under the EGTRRA revision. By carefully analyzing your retirement account structure, you may be able to implement a strategy that will allow you to make a Roth conversion in 2010 with a greatly reduced current tax impact.

Strategy 2: Since income limits are still in place limiting direct contributions to Roth IRAs, many individuals may not be able to take advantage of the power of the Roth IRA. However, since the limit for conversion has been eliminated, you can implement a two-step strategy that will accomplish the goal of contributing to a Roth IRA. As depicted in the chart, a contribution can be made to a Traditional IRA each year. The following year, those assets are converted to a Roth IRA. The strategy can become more sophisticated by establishing two Roth IRAs. The first Roth is for initial conversions from the Traditional IRA. If the value of the account increases, the assets are rolled into Roth number 2 at the end of the year. If the value of the account decreases, the assets are recharacterized into the Traditional IRA. By recharacterizing the assets to a Traditional IRA, you avoid paying tax on gains that you never actually realized.

It is essential that you have your Associate and tax consultant run projections to determine the best conversion strategy for your individual situation. Additionally, they should run tax projections for tax years affected by the conversion process to help plan for or avoid undesirable tax consequences like the Alternative Minimum Tax (AMT) or loss of tax credits or deductions.

Bottom Line:

This is a unique opportunity to position retirement assets for maximum flexibility in your retirement years. Unfortunately, there is no "one-size-fits-all" answer as to whether a Roth conversion makes sense for you. This is due to the fact that you are dealing with the vagaries of stock market returns, tax rate changes and the general uncertainties of assorted future events. Because there is complexity involved, it is essential that you have your Financial Adviser and Tax Consultant run projections to determine if this is appropriate for you. If it is, they should work together to develop the best conversion strategy for your individual financial situation. Additionally, they should run tax projections for tax years affected by the conversion process to help plan for, or avoid, undesirable tax consequences like the Alternative Minimum Tax (AMT) or loss of tax credits or deductions. For more information on Roth conversions and whether it makes sense for your situation, contact The Henssler Financial Group at 770-429-9166 or comments@henssler.com.

All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.