Last-Minute Roth Conversion and Recharacterization Rules
Dear Tax Talk,
In Bankrate's article titled "7 Steps to a 2010 Roth IRA Conversion," it says that under IRS rules, you have to consider the entire value of all your IRAs when converting and figuring taxes on the Roth conversions.
Do you have to consider 401(k)s? I have one IRA and money in a 401(k). Eighty percent of the IRA has already been taxed, and none of the 401(k) has been taxed. Some people tell me you have to roll all accounts; some say it just pertains to IRAs. Thank you.
-- Steve
Dear Steve,
I'm not a fan of Roth individual retirement account, or IRA, conversions. I figure, why pay now when you don't know what the future holds? Conversions could become a better deal down the road, or you could lose value in your account, eliminating the gain you paid taxes on. In fact, you have until Oct. 17 to recharacterize any Roth IRA conversion you made last year. If your account has decreased in value, you may want to take advantage of this opportunity and try reconverting again for this year while recognizing less income and paying less in taxes.
Generally when you convert an IRA to a Roth IRA, you only consider the values in your IRA accounts in determining the taxable income resulting from the conversion. That is, in Amy Buttell's example in step four of her article, you would only consider your IRA balances in determining the pro rata part of any possible basis you have. If you don't have nondeductible IRAs, then the total converted amount is includible in income. Remember that for 2010 conversions, you're not recognizing the conversion income until your 2011 and 2012 tax returns (part 3 of Form 8606).
Remember also that you may be able to convert your 401(k) and 403(b) employer retirement plans to a Roth account. In 2011, Section 457(b) plans become eligible for rollover. Your employer's plan has to permit the rollover to an employer Roth account. You also have to be willing to shell out the tax money from other sources such as savings or income.
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