2010 Roth IRA Rollover Rules

What are the 2010 Roth IRA rollover rules?

If you're considering a Roth IRA rollover in 2010 or in the years thereafter, you need to know.

Why?

Because as of 2010, the rules dramatically change for Roth IRA conversions.

But before addressing the details of those rules, let's review the current Roth IRA rollover rules.

To perform a successful rollover, you need to do the following things...

• Have adjustable gross income (AGI) under the IRS limits
• Have an open/established Roth IRA account
• Move distributions from your qualified plan to your Roth IRA within 60 days
• Pay taxes on rollover distributions (if necessary)

It's important to know each of these rules when performing a Roth IRA rollover, but the 2010 rule changes significantly alter this list ? particularly the first bullet point... Adjustable gross income (AGI) under the IRS limits.

So let's focus on that...

Current Roth IRA Rollover Income Limit

Under the current rules, if you want to roll over funds from your 401k, Traditional IRA, 403b, or another qualified plan to your Roth IRA, you can only do so if your adjustable gross income (AGI) is no more than $100,000.

This rule essentially bars people with six figure incomes from making Roth IRA conversions.

In addition, the current law (2009) prohibits anyone who is married and filing a separate tax return from engaging in a Roth IRA conversion.

If you find yourself in either one of these categories, you're out of luck when it comes to making a Roth IRA conversion.

However, your luck is about to change...

Why?

Because of modifications to the 2010 Roth IRA rollover rules. Starting on January 2, 2010, anyone can make a Roth IRA conversion, regardless of income or tax filing status.

2010 Roth IRA Rollover Income Limit

The new 2010 Roth IRA rollover rules eliminate the $100,000 adjustable gross income (AGI) limit on making a Roth IRA conversion. The new rules also eliminate the prohibition on conversions for married persons filing separate tax returns.

So if you've missed out on the benefits of a Roth IRA in years past because of your income or tax filing status, 2010 offers you a great opportunity.

For example, let's say you have a Traditional IRA worth $89,500, and your adjustable gross income (AGI) is $120,000.

In 2010, you can perform a Traditional IRA rollover to a Roth IRA even though your AGI exceeds $100,000.

Of course, whenever you perform a rollover, the odds are pretty good that you'll owe taxes, and that's an important subject for us to cover.

Why?

Because the 2010 Roth IRA rollover tax rules change as well...!

Paying Taxes On A 2010 Roth IRA Rollover

For 2010 Roth IRA rollovers, the IRS gives you the option to pay 50% of your tax bill in 2011, and 50% in 2012.

But keep in mind, this only applies to conversions performed in 2010...

If you perform a rollover in 2011, the taxes are due in 2011. The same is true for 2012 and beyond. So this is a one-time deal.

So how are the taxes calculated?

2010 Roth IRA rollover taxes are calculated the same as any other rollover. Your tax bracket (using pre-rollover AGI) determines your tax rate, and that tax rate is applied to all taxable portions of your rollover distribution.

For example, let's say you have a SIMPLE IRA worth $70,000, and you want to perform a rollover to a Roth IRA. Your current tax bracket is 30%.

If you take advantage of the tax deferral provision, 50% of your tax bill is due in 2011, while the remainder is due in 2012.

So, you pay $10,500 in taxes in 2011. (50% of $70,000 at 30%)

And...

You pay $10,500 in taxes in 2012. (50% of $70,000 at 30%)

This gives you an extra two years to come up with the funds to pay your tax bill. So instead of owing the entire $21,000 in the year 2010, your tax bill is spread out over the course of two years.

That said, there is a potential downside to the tax deferral provision...

Keep in mind that if you plan to take advantage of the 2010 Roth IRA rollover tax deferral rule, the tax rate applied for both years is determined by your personal income tax bracket for the year in question, NOT the year in which you performed the rollover.

What does that mean?

It means if your income markedly increases in 2012 (thus, pushing you into a higher tax bracket), then you will owe more taxes than you otherwise would owe if you stay in the same tax bracket as 2011...

That's one risk of this provision.

For instance, let's say it's 2010. You have a fully taxable 401k worth $100,000, and you're currently in the 15% tax bracket. You perform a 401k rollover to a Roth IRA and decide to take advantage of the 2011/2012 tax deferral.

As a result, you pay $7,500 in taxes in 2011. (50% of $100,000 at 15%)

But, in the 2012 tax year, you get a big bonus at work, pushing you into the 25% income tax bracket.

As a result, you pay $12,500 in taxes in 2012. (50% of $100,000 at 25%)

Do you see why this poses a potential pitfall?

Had you simply paid the taxes in full in 2010, instead of taking advantage of the one time deferral, your total tax bill would've been $15,000. Instead, it turned out to be $20,000.

So if you plan to take advantage of the 2010 tax deferral rule, make sure you're aware of the potential complications and plan accordingly...

Conversion Limit, NOT Contribution Limit

Even though the $100,000 income limit on making a Roth IRA conversion expires in 2010, that doesn't mean that the income limit for making an annual Roth IRA contribution also expires.

If you earn more than the Roth IRA phase out limits, then you can NOT make new contributions to your Roth IRA.

So what are the limits?

As of 2009, the maximum income limits for making a Roth IRA contribution are...

• $176,000 if you're married filing a joint tax return
• $10,000 if you're married, filing a separate return, and lived with your spouse for any part of the tax year
• $120,000 if you file your taxes as single, head of household, or married filing separately and did not live with your spouse for any part of the tax year

If your modified adjusted gross income (MAGI) exceeds the limit, you can NOT make a direct Roth IRA contribution for the current tax year.

So remember, the 2010 Roth IRA rule changes do NOT effect the Roth IRA contribution limits. What they do effect is the $100,000 AGI limit on Roth IRA conversions.

And that's where you see a sign of light if your income is too high to make a Roth IRA contribution.

Why?

Because thanks to the new 2010 Roth IRA conversion rules, you can take advantage of a backdoor approach for making Roth IRA contributions.

All you have to do is make non-deductible contributions to a Traditional IRA, then immediately convert your Traditional IRA to a Roth IRA.

This effectively eliminates the income limit on making a Roth IRA contribution.

Need an example?

Let's say you're married, 40 years old, and earn $250,000 per year. For years, you've wanted to open and contribute to a Roth IRA, but you can't. Under current and future IRS rules, you're prohibited from making any direct contributions to a Roth IRA.

Why?

Because your modified adjusted gross income (MAGI) exceeds $176,000.

But as long as you make non-deductible (after-tax) contributions, you don't have to worry about income limits restricting your ability to contribute to a Traditional IRA.

As a result, you can fully fund your Traditional IRA to the tune of $5,000.

Once you've done that, you can convert your Traditional IRA to a Roth IRA. And since you made contributions to your Traditional IRA with after-tax dollars, converting your IRA to a Roth IRA does NOT trigger a taxable event.

That means your Traditional IRA funds simply roll over into your Roth IRA tax-free and penalty-free.

And what does that mean?

It means, for all intents and purposes, the income limits on making a Roth IRA contribution no longer exist.

So if you're a high income earner, take advantage of the opportunities the 2010 Roth IRA rule changes offer!

Benefits Of A 2010 Roth IRA Rollover

So now that you know the 2010 conversion rules, what are the benefits of a 2010 Roth IRA rollover?

Depending on your personal financial situation, the benefits can be numerous. For instance, the new rules provide you with the opportunity to...

• Defer rollover distribution taxes until 2011 & 2012
• Open a Roth IRA if you're a high income earner
• Effectively contribute to a Roth IRA if you?ve earned too much in the past

The latter point is especially significant.

Why?

Because unless Congress closes the loophole or reinstitutes the $100,000 income limit on Roth IRA conversions, it essentially eliminates the Roth IRA income limits. And unlike the 2010 tax deferral provision, this is something you can take advantage of year after year after year.

So as of 2010, you can open and fund a Roth IRA, regardless of your income...

Conclusion

The changeover to the new 2010 Roth IRA rollover rules represents a significant change in the world of retirement planning.

If you've previously earned too much to meet the Roth IRA eligibility requirements, 2010 offers you the opportunity to establish, and continue contributing to, your own Roth IRA.

While the Roth IRA income limits remain intact, the $100,000 limit on Roth IRA conversions disappears, effectively eliminating any income caps on making a contribution.

So if you currently earn more than $100,000, the year 2010 represents the opportunity of a lifetime. Don't miss out!

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