As the end of the 2010 tax year comes to a close, an interesting question is coming up more often.
- Should I convert my IRA to a Roth in 2010?
There is a special 2010 tax trick that allows you to convert your traditional IRA to a Roth IRA and spread the taxes from the IRA conversion out over the next two tax years. That little tax secret expires at the end of 2010, which means that unless you convert your IRA to a Roth before year-end, you can’t lower your taxes with that tax loophole.
Roth IRA conversions are open to everyone regardless of income from now on. However, there are still Roth IRA income limits for contributions.
Is It A Good Idea To Convert IRAs in 2010?
Normally, making a big tax move like a Roth conversion late in the year is not a good tax strategy for most people because it doesn’t give you any time to compensate for it.
For example, if you were to convert an IRA to a Roth IRA in 2011, you will owe income taxes on the amount of money converted, minus any non-deductible IRA contributions you made to the traditional IRA or 401k you are converting to a Roth. Without the special tax rules for 2010, all of those taxes are due when you pay your 2011 taxes (filed by April, 2012). If you converted your IRA early in 2011, you could adjust your tax withholdings on your W-2 at work, or increase your estimated quarterly tax payments if you are a small business owner. Over several months, those small changes would blunt the tax hit of the conversion.
On the other hand, if you converted your IRA near the end of 2011 and generated a $10,000 tax spike, there isn’t much you can do about it. You can adjust your withholdings, but unless it is a big change, it won’t add up to much. Adjusting your W2 to withhold an extra $300 a month starting in February adds up to $3,000 by December. Doing the same thing in November adds up to just $600.
Best Tax Move For 2010 End of Year
For 2010, however, there are special tax rules for IRA conversions that make this year the right time to convert your traditional IRA to a Roth IRA. In fact, few 2010 year-end tax moves can save you more on your taxes.
For 2010 only, you can report the conversion income from your Roth IRA on your 2011 and 2012 tax returns. Spreading the Roth conversion taxes out over two years means you only have to pay half in 2011, and the other half in 2012.
Even if you have the money laying around to pay for your conversion, this is still a smart financial move.
If your Roth conversion generated income taxes of $10,000, you could put $5,000 in a 1-year CD or a high-interest money market account to pay the taxes in 2011, and put the other $5,000 in a 2-year CD or MMA to pay the taxes in 2012. Not only do you not have to worry about the Roth IRA conversion taxes, you can make money on your tax liabilities by deferring them for a year.
If you are planning to convert your IRA in the near future, convert it now before the 2010 tax-year ends. You’ll have plenty of time to plan for the taxes thanks to the special tax treatment you get in 2010.