Roth Conversion Strategies – Part II

Last week, I discussed the general rules and who were the best candidates for converting a traditional IRA to a Roth IRA recognizing that beginning in 2010, there are no longer income limitations on who can do a conversion. This week, I’ll show you some little-known strategies you can use to take advantage of the opportunity Roth IRAs offer.

Roth Strategy #1. If you are an individual tax filer with modified adjusted gross income exceeding $120,000 or a joint filer with MAGI exceeding $176,000 in 2009, you’re not eligible to make a Roth contribution. You are eligible, however, to make a non-deductible IRA contribution of up to $5,000 plus an additional $1,000 if you were age 50 before December 31st 2009. Here’s the strategy: prior to the April 15, 2010 deadline, make a maximum contribution to a non-deductable IRA, then convert it to a Roth IRA. Since there is no gain, there will be no tax. Plan on doing this every year as a way to get more money into your Roth account.
Roth Strategy #2. If you have both deductible and non-deductible IRA accounts, you don’t get to ‘cherry pick’ which ones to convert, but rather you must ‘aggregate’ all of your IRA accounts in order to determine your tax liability. For example, say you have a non-deductible IRA where you have contributed $25,000 with no gain plus a deductible IRA that you have contributed $25,000 with no gain. You decide to convert $25,000 to a Roth. What is your reportable gain? The answer is $12,500, or fifty percent of the combined accounts. Here’s the strategy: Many company retirement plans allow you to roll over IRA accounts into the company retirement account such as the 401k plan. You roll over the deductible IRA into the company plan, leaving the non-deductible IRA which you then convert to a Roth. The result is that you have effectively isolated your non-deductible IRA and minimized the tax consequences of conversion. If you’re self-employed and have a Simplified Employee Pension plan (SEP) or other similar plan, you can use this same strategy.
Roth Strategy #3. Do your Roth conversion early in 2010, especially if you believe the stock market will rise this year. If you wait until the end of the year to do the conversion and the market rises, you’ll owe more taxes on your gains. If you convert early and you’re wrong about the market, you get a free ‘look-back’ which allows you to ‘un-convert’ your Roth up until when you file your tax return including extensions. Be sure to keep these annual Roth conversions separate from your other Roth account for ease of un-converting, if needed.
Roth Strategy #4. This is a variation of Strategy #3 above. Consider separating your IRA accounts by investment type and then converting your most aggressive investments to a Roth early in the year. If the investments do well, consider it a good conversion. If the investments do poorly, you can ‘un-convert’.