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Plan Well, Retire Well

Saving and investing your money

Your Roth Conversion Questions Answered


Several of you have sent questions about Roth conversions since my previous posts: The (New) Rules and Factors to Consider. Today, I'll review some of those questions, and share my responses with you.

Question #1 – Conversion calculators

how can I get a calculation of whether a conversion to a roth is right for us?

--R.N., Naperville

Dear R.N.,

There are lots of calculators available on the Internet. I'd suggest trying a couple of different ones, since they don't all ask for the exact same inputs for the calculation.

Some that I have played with are:

There may be others on the web that are better than these, but these are the ones I happened to try out when doing the research for my blog posts.

The "answer" you get from most of these (whether converting to a Roth or staying with your traditional IRA will yields the best result) will probably be consistent, and that's the important thing. But the dollar amounts they arrive at may be significantly different. That doesn't mean that they disagree - the difference is whether they include or exclude the money that would be used to pay the taxes.

You could also work with a financial planner to evaluate this decision for you. They would be able to consider factors that a calculator can't, such as whether other characteristics of a Roth or a Traditional meet your needs better. If you'd like to go that route, please check out our guide to Choosing a Financial Professional at http://web.extension.illinois.edu/financialpro/.

Question #2: The price of converting

We moved money to a Roth in Dec 09. Now I find we will owe not only big bucks in penalties, increase to 85% in social security and a very big income tax bill. As for the penalties, is there no waiver for year-long estimated payments, since we didn't know we would do this for the entire year. AND most of all do we need to reverse this decision? HELP QUICK

-- P.L., New Hampshire

Below are some of the points I covered in my response to P.L. Note: Extension's role is to educate rather than to provide advice, so these points discuss facts but should not be construed as making any sort of recommendation about what P.L.- or you - should do.

The rules:

The amount you convert from an IRA or other retirement account is taxable income. Not only will you owe tax on that amount, you may need to pay estimated taxes or increase your withholding to avoid penalties for underpayment. IRS Publication 505, Tax Withholding and Estimated Tax, includes worksheets to help you figure out if you need to pay estimated taxes. You can avoid owing an underpayment penalty by making sure your withholding and refundable credits total at least 90% of your current year tax or 100% of your prior year tax (110% for high income taxpayers with adjusted gross income of over $150,000 or $75,000 if married filing separately).Use Form 2210 and instructions to determine if you have a penalty, and how to calculate it, when you file your taxes.

There are special rules for calculating estimated taxes in situations like P.L.'s, where the income is at the end of the year rather than being spread equally across the entire year. That could also reduce the penalty, if any.

This additional income may push you into a higher tax bracket, and if you're receiving Social Security benefits, it may cause some (or more) of those benefits to be taxed.

Another option:

What if you decide that converting was a bad idea? IRS Publication 590 Individual Retirement Arrangements (IRAs) has the answer. Recharacterization is a way of undoing a conversion, so that it is treated as if the conversion had never happened. (You can also recharacterize contributions). To recharacterize a conversion, you transfer the money plus earnings back to the original type of account – a traditional IRA. But the window for recharactization ends on the due date (including extensions) for the tax return for the year in which the conversion was made. If you converted in December 2009, you have until October 15, 2010 – IF you file your taxes in a timely fashion.

It would appear that recharacterizing would resolve all three issues P.L listed. Going forward, converting just a portion of the account each year might help them avoid paying tax on so much of their Social Security or being pushed into a higher tax bracket. Converting a smaller amount each year would reduce the likelihood that you'd need to pay estimated taxes, but you have to do the calculations to be sure.

Where to get help:

A qualified tax professional could help you work through an issue like this. You might consider either a CPA or an enrolled agent. You can find a CPA who specializes in personal finance (has the PFS designation) at http://pfp.aicpa.org/Community/Find+a+CPA+PFS+Near+You.htm. There is no centralized database of Enrolled Agents.

You could also look for a fee-only financial planner, most of whom should be well-versed in this. Check www.napfa.org and look for a planner who will work on an hourly (as-needed) basis, which means they would work with someone on a single specific issue such as yours. Before you schedule a meeting, ask if they help clients with this specific tax issue – most probably do, but ask first. And/or check http://www.garrettplanningnetwork.com/ whose members are also all fee-only, all of whom work on an ourly basis.

More questions

Check my next blog post for more quesions submitted by readers.



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