Is a Conversion to a Roth IRA in Your Future?
Trusts & Estates Law Update 12/10/09
Prior to 2010, individuals whose annual household adjusted gross income exceeded $100,000 were ineligible to convert a traditional IRA to a Roth IRA. But, the Tax Increase Prevention and Reconciliation Act of 2005 - signed into law on May 17, 2006 - removed these eligibility limitations, effective January 1, 2010. As a result, previously ineligible clients can now consider the benefits of converting to a Roth IRA for 2010 and beyond.
A Roth IRA is a special class of IRA that offers many unique tax benefits. Unlike a traditional IRA, a Roth IRA has the following favorable features:
- Once funded with after-tax dollars, 100 percent of the growth is tax-exempt.
- "Qualified Distributions" from a Roth IRA are tax-exempt.
- Withdrawal flexibility exists because there are no mandatory withdrawals of required minimum distributions at age 70½ for the IRA owner or his or her surviving spouse, if the surviving spouse elects to rollover the decedent spouse's Roth IRA.
A client can convert all or a portion of his or her traditional IRA to a Roth IRA. In addition, a client who converts in 2010 has two options for paying income taxes on the conversion amount.
- Option One: Report and pay income taxes on the entire conversion amount on the 2010 income tax return; or
- Option Two: Report the 2010 conversion in two equal installments on the 2011 and 2012 income tax returns.
The decision to convert to a Roth IRA depends on many variables, including but not limited to the following:
- Assumptions regarding future tax rates.
- Financial resources available to the client to pay conversion income taxes.
- Projected income needs of the client during retirement.
- Availability to the client of charitable deduction carryforwards, investment tax credits, or other deductions that can offset the income taxes on the conversion.
Because the decision to convert a traditional IRA to a Roth IRA depends on facts and circumstances unique to each client, we encourage you to contact an attorney in our practice group to identify whether a conversion strategy is beneficial for you.
Wisconsin Law on 2010 Conversions to Roth IRAs
To date, the Wisconsin legislature has not adopted the TIPRA provisions on conversions to Roth IRAs. Thus, a Wisconsin taxpayer whose 2010 household adjusted gross income is greater than $100,000 and who elects to convert a traditional IRA to a Roth IRA in 2010, must report the converted amount as income on the taxpayer's 2010 Wisconsin income tax return. In addition, if the taxpayer who converted is under age 59½, Wisconsin will impose a one-time 3.33 percent early distribution penalty and a 2 percent penalty for an excess contribution to a Roth IRA for each year the excess contribution continues. There has been much criticism of the Wisconsin tax treatment of conversions to Roth IRAs. When the legislature reconvenes in January 2010 or earlier, it may adopt an approach which parallels the federal treatment of conversions to Roth IRAs.
If you have any questions on this client update or other related Trusts and Estates issues, please contact your Quarles & Brady attorney.