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 Roth
Conversions and Their Tax Consequences
by John Carl, President,
Retirement Learning Center
With the upcoming 2010 law changes that
will liberalize conversions to Roth IRAs, our ERISA
consultants on the Columbia Management Resource Desk have
been answering an increasing number of calls from financial
advisors who have specific questions about Roth IRA
conversions and the tax implications for their clients.
In 2010,
significant changes to Roth IRA conversions will occur.
First, the $100,000 modified adjusted gross income (MAGI)
limit for conversion eligibility will be eliminated.
Second, the joint filing
requirement for married individuals will be eliminated, and
third, individuals who convert assets to Roth IRAs in 2010
may choose to spread the taxable amount of the
conversion—pro rata—over 2011 and 2012. Alternatively, they
may choose to include the taxable amount as income for 2010.
(Note: Individuals who convert before and after 2010 must
include the taxable amount of the conversion in income in
the year of the conversion.)
Through our
relationship with the
Columbia
Management
Learning
Center,
we regularly guide Columbia Management’s financial advisor
partners through the rules and regulations that apply to
Roth IRA conversions.
A
recent call with an Ameriprise advisor in Virginia
is representative of a typical question on this subject.
The advisor queried: How does
a taxpayer determine the taxable amount of a Roth IRA
conversion?
Highlights of Recommendations
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If an individual converts an IRA or qualified plan to a
Roth IRA, he/she must pay taxes on any pre-tax
assets that are converted.
-
If an
individual has both pre-tax and after-tax IRA or
qualified plan assets, the IRS requires him/her to treat
a conversion amount as consisting of a pro rata share of
pre-tax and after-tax dollars.
-
A taxpayer, with the assistance
of his/her tax professional, calculates the taxable
portion of an IRA-to-Roth IRA conversion by completing
IRS Form 8606,
Nondeductible IRAs.
This calculation takes into
consideration the pre-tax and after-tax contributions in
all of the taxpayer’s non-Roth IRAs to determine the
taxable portion.
-
A plan
participant who converts his/her 401(k) to a Roth IRA
does not use IRS Form 8606 to determine the taxable
portion of a conversion but, instead, is subject to the
basis recovery rules applicable to qualified retirement
plans for post-1986 after-tax assets. (Pre-1987
after-tax assets may be distributed without associated
pre-tax earnings.) The plan administrator is responsible
for reporting the taxable and nontaxable portion of a
qualified plan-to-Roth IRA conversion on IRS Form
1099-R.
Conclusion
Determining the taxable portion of a
Roth IRA conversion is a complicated matter, and clients
should consult their tax professionals for precise
information.
Nevertheless, it is important for financial advisors to have
a general understanding of the rules.
That’s why having a reliable source available, such
as the Columbia Management Resource Desk, to guide advisors
through the Roth conversion rules can turn a difficult
client question into an opportunity to differentiate the
advisor and build relationships.
©2009 Retirement Learning Center
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