Ask The Taxgirl: Roth Conversions

Taxpayer asks:

Hi,
I am currently retired, age of 60.
I have pension income of $48K / yr and investment income of 20K/ yr.
What are the tax consequences of converting a 401k of $120K to a Roth IRA?
To limit taxes, should the conversion be structured over several years?

Thanks,

Taxgirl says:

Retirement planning is so not my forte. So I’m gonna tell you the tax consequences of your transaction – but I’m not going to advise as to whether it makes sense for you or not. I would strongly advise that you check with a retirement or financial planner to make sure that this is the best option for you.

This is the scoop. As of last year, you can rollover a 401(k) into a Roth IRA. When Roth IRAs were originally conceived, this wasn’t something that was allowed.

Since Roth IRAs are funded with after-tax dollars, the amount that you roll over is subject to federal income tax. Specifically, any amounts that would have been taxable had you simply pulled out the funds and not funded the Roth IRA are reportable as gross income.

You’re under the income limit for making the rollover – though that will not matter in 2010. In 2006, President Bush signed a bill that changed the eligibility rules for Roth IRA conversions. For 2010 (and so far, only for 2010), taxpayers with modified adjusted gross income of more than $100,000 can convert qualified retirement funds to a Roth IRA. Additionally, for 2010, income tax due on conversions can be spread included as income and paid in 2011 and 2012. This can be a great help, assuming that you remember to put aside enough money to pay the tax bill in those years.

The advantage, of course, is that after all is said and done, future distributions from the Roth IRA are income tax-free.

There are some other conversions, limitations, and ordering rules that you should familiarize yourself with before making the decision to make the rollover. You may wish to take advantage of that 2010 exclusion – so don’t rush into anything. Find someone who knows what they’re talking about and can run the numbers for you for comparison. Roth IRAs can be great vehicles but they’re not for everyone.

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
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Kelly Phillips Erb

Kelly Phillips Erb is a tax attorney, tax writer, and podcaster.

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