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Everyone is now free to convert to convert an IRA to Roth.  The $100,000 cap on adjusted gross income (AGI) has been lifted beginning in 2010.  The income ceiling for Roth contributions however remains in place.  Contributions begin to be phased out for joint filers when their AGI reaches $167,000 and is eliminated at $177,000.  For single filers the phase out begins at $105,000 and is eliminated at $120,000.  If your AGI is above these levels you can still make a contribution to a Roth by first making a non-deductible contribution to a traditional IRA and then immediately converting it to a Roth.  There are no income limitations to making non-deductible IRA contributions.  However, there may be tax implications to doing this if you have other IRA accounts. 

Converting an IRA to a Roth generally makes sense if you expect to be in the same or a higher tax bracket in retirement.  You should also be able to afford to pay the tax on the conversion from other sources so the entire amount of the conversion remains in the Roth.  A significant advantage to convert this year is the ability to defer paying the tax on your conversion.  Taxpayers that make Roth conversions in 2010 can elect to defer 50% of the income to 2011 and 50% to 2012.  The question is – should you convert and if so how much of your IRA should be converted?

WHEN IN DOUBT – CONVERT!  AND DO IT NOW

Many people have asked me how I can be so sure that converting to a Roth is the right thing when tax law is so uncertain.  We know that the Bush tax cuts are expiring at the end of 2010 but many people believe they will be extended for some taxpayers.  The uncertainty of the health care legislation and how it will be paid for could be another tax trap for upper income people.  Wouldn’t it be better to wait until the tax law changes have been passed?

You don’t need to wait because you can always undo your Roth conversion until your filing deadline.  That deadline is April 15, 2011 and could be as late as October 15, 2011 if you file for extension.  Up until the deadline you could undo all or part of your conversion and it would be like you never converted in the first place.  My advice is to convert the maximum amount you can afford to pay for with funds outside of the IRA.  Let the financial markets work for you from now until April 2011.  Rising financial markets and favorable tax laws may signal that you want to keep everything in the Roth and pay the tax.  If not, undo some or the conversion until the tax bill is where you want it to be.  Next April it will be too late to make a conversion for 2010.  It is always better to convert too much and then undo part of it later than to convert too little and not be able to do anything about it after the year has ended.

Start by doing a projection of what your taxable income will be in 2010 without the IRA conversion.  How much income can you add to 2010 without going into the next higher tax bracket?  The 2010 income tax brackets are a little higher than 2009.  Tax brackets are indexed to inflation each year.  Keep this in mind when you are deciding whether to defer income from the conversion to 2011 and 2012.  Tax rates for the brackets are the same as 2009 but this may change in 2011.  Use this chart to help plan for 2010.

http://www.rodgers-associates.com/files/January20Newsletter.pdf

 SHOULD YOU PAY THE TAX IN 2010 OR DEFER IT

 Fortunately you won’t have to make this decision until you are ready to file in 2011.  The answer to this will greatly depend on whether Congress extends the Bush tax cuts or not.  The President has pledged to not increase income taxes for those earning less than $250,000.  This would imply that the Bush tax cuts will be extended to everyone earning less than that amount.  Anyone earning more that $250,000 will see the top tax rate increase to 39.6%.  Keep in mind that the amount of the conversion needs to be included in this amount.  I would advise you to plan to keep your income plus conversions under $250,000 if you think you will be deferring the income into 2011 and 2012.

Higher income taxpayers should consider the other benefits of paying the tax in 2010.  You will not lose any itemized deductions and personal exemptions in 2010 because all the phase outs are finally eliminated.  In 2011, itemized deductions (other than medical expenses, investment interest and casualty losses) will again need to be reduced by 3% of the amount of your AGI that exceeds $170,000.  Personal exemptions are reduced by 2% of each $2,500 of AGI over $255,000 for joint filers and $170,000 for singles.

A final consideration for seniors on Medicare is the premium hikes based on AGI.  Income from Roth conversions could cause your Medicare premiums to increase significantly.  The premiums for those already on Medicare Part B will remain at $96.40 per month in 2010. For anyone signing up in 2010 the premium will start at $110.50 per month.  Premiums are increased based on AGI according to the following schedule:

http://www.rodgers-associates.com/files/January20Newsletter.pdf