Making sense of all the IRA Options

Everybody is chattering about conversion right now, particularly with the 2010 release of ceilings on who

can convert. However, is it really the right thing to do? That depends on your personal situation, not your

advisor or friend’s account.

The first thing to remember is that when you convert to a Roth IRA account, you will owe taxes. Yes,

your funds can no longer be taxed again, but that pre-tax $100,000 is going to be a lot less after taxes.

Second, to make a conversion technically work, you will need an existing Roth IRA account to put your

money into. Now the law says you can’t deposit into such an account if you make over a certain amount,

but it doesn’t say you can’t open the account. It would just be a balance of $0 if nothing else happens.

Third, the conversion requires paperwork. You have to liquidate your holdings since a conversion cannot

transfer market instruments. The transfer has to be in funds (US dollars). So your investment holdings

will need to be sold (but if you do this right it’s just for a short while and you can buy them back again in

the right Roth IRA Account). The paperwork tells your account administrator exactly how much is being

converted and your authorization to do so.

On a tax basis you can decide if the administrator withholds taxable funds for you or if you will pay them

yourself. Remember, the administrator will send the transactions to the IRS at the end of the tax year, so

don’t forget later on to pay the taxes. However, how you pay the taxes can be to your benefit.

Just because you owe taxes on a conversion doesn’t mean that you need to pay it out of the new Roth

IRA account. If you can manage to pay the cost from other funds, then you can in effect keep the

balance of your new Roth whole and reinvest that same amount again.

Your conversion taxes will depend on if your Traditional IRA account deposits were deductible or not.

Deductible deposits will result in taxes owed after conversion. Non-deductible deposits, however, mean

that your conversion will be tax-free. If the deposits are a mix, then the taxable amount is the

percentage that was deposited as deductible. Ergo, this is why it’s so important to keep your account

documentation for your IRA Accounts. The paperwork proves to the IRS how much you actually owe in

conversion taxes.

Conversion taxes are owed at the end of the tax year that you had the conversion. However, 2010 some

leeway is provided. You can choose to either pay the tax entirely with your 2010 taxes, or you can split

the cost up on your 2011 and 2012 tax filings. This choice is only available in 2010 and not available

afterwards.