Tax and Money Tip of the Week
Roth IRA Conversions: Opportunities and
Deadlines | September 19th, 2012 | No. 110
Potential increase in federal income tax may make 2012 Roth conversions attractive
When you convert a traditional IRA to a Roth IRA, the conversion is generally taxed as ordinary income (except for any after-tax, nondeductible contributions you’ve made). With the “Bush tax cuts” set to expire at the end of 2012, federal income tax rates will jump up in 2013. Unless Congress acts, we’ll go from six federal tax brackets (10%, 15%, 25%, 28%, 33%, and 35%) to five (15%, 28%, 31%, 36%, and 39.6%). While there continues to be discussion about extending the expiring tax cuts, many believe there’s little chance of resolution until after the November election.
While no one can predict what Congress will ultimately do (or not do), 2012 may present an opportunity to convert a traditional IRA to a Roth IRA at a potentially lower tax cost than if you wait until 2013.
You can convert now, or you can take a wait-and-see approach–you have until December 31 to make a 2012 Roth conversion. Either way, if converting turns out to be the wrong decision, you’ll have until October 15, 2013, to “undo” your conversion, and it will be treated for federal tax purposes as if it never occurred.
Keep in mind that the potential 2013 tax rate increase is just one factor to consider when deciding if and when you should convert a traditional IRA to a Roth IRA. If you’ll need to pay the conversion tax with IRA funds, or if you think you’ll be in a lower tax bracket when you begin taking distributions, a Roth conversion may not be right for you.
You have until October 15, 2012, to undo a 2011 Roth conversion
If you converted a traditional IRA to a Roth IRA in 2011, and your Roth IRA has sustained losses, you may want to consider whether it makes sense to undo (recharacterize) your conversion. You have until October 15, 2012, to undo your 2011 conversion. (If you’ve already filed your federal income tax return for 2011, you’ll need to file an amended return if you recharacterize.) A recharacterization can help you avoid paying income tax on the value of IRA assets that have been lost. When you recharacterize, your conversion is treated for tax purposes as if it never happened.
For example, assume you converted a fully taxable traditional IRA worth $100,000 to a Roth IRA in 2011. However, due to market volatility, that Roth IRA is now worth only $60,000. If you don’t undo the conversion you’ll pay federal (and possibly state) income tax on $100,000, even though the current value of those assets is only $60,000. If you undo the conversion, you’ll be treated for tax purposes as if the conversion never happened, and you’ll wind up with a traditional IRA worth $60,000–and no resulting tax bill.
If you recharacterize your 2011 conversion, you’re allowed to convert those dollars (and any earnings) to a Roth IRA again (“reconvert”) but you’ll have to wait 30 days, starting with the day you transferred the Roth dollars back to a traditional IRA. Keep in mind that even though the amount you recharacterized, and any earnings, is subject to a 30-day waiting period, any other amounts in your traditional IRAs are not subject to the waiting period, and you can convert all or part of those dollars to a Roth IRA at any time.
Whether it makes sense to recharacterize your Roth conversion depends on several factors, including the extent of the losses in your Roth IRA, and your expectations of where the markets may be headed.
Call me to help decide if a recharacterization is right for you.
Questions or Comments?
You can add comments on the blog, call 919-847-2981, or visit our web site. We look forward to hearing from you.
Mark Vitek, CPA/PFS, CFP®
…until next week.
Currently, the exemptions for federal gift tax, estate tax, and generation-skipping transfer (GST) tax are at historic highs, and the gift, estate, and GST tax rates are at historic lows. But, in 2013, the exemptions are scheduled to substantially decrease, and the tax rates are scheduled to substantially increase.
This is the time of year in our CPA practice that I work with small business owners and individuals to perform tax checkups to help them project their tax liabilities for 2012 and make tax saving recommendations of moves they can make between now and year-end. Frequently, just defining the amount of taxes they owe via these planning services helps manage their cash flow so the businesses and individuals don’t have a big amount due and/or surprise each Spring when they prepare their tax returns.
Here is a mid-summer reminder for all the business owners who have put off filing your company’s 2011 income tax return.
The IRS has announced the new inflation adjusted amounts for Health Savings Accounts (HSAs). For calendar year 2013, the annual contribution limit for an individual with self-only coverage will be $3,250, up from $3,100 in 2012. The annual contribution limit for an individual with family coverage under a high deductible plan will be $6,450, which is an increase of $200 over the 2012 limit.
On June 28, 2012, the U.S. Supreme Court ruled, in a landmark decision, that the Patient Protection and Affordable Care Act (ACA), including the provision that most Americans carry health insurance or pay a penalty, is constitutional.
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