roth ira conversion: when is it effective?
We are planning to convert our existing IRA to a Roth IRA this month (September).
My husband is 71 and I am 69.
We will take distributions from the converted Roth account in November and December.
When is the conversion effective?
Will the distributions in November and December be tax-free. Will the distributions I take in 2011 be tax free?
Would we need to file and pay estimated taxes (1040 ES) this year if we intend to report the income on our 2010 tax return?
When would we need to pay estimated taxes(1040 ES) if we elect to report and pay half the income in 2011 and half in 2012?
What happens if you recharacterize the conversion? Do you get back your estimated taxes paid? Do you have to file a modified 2010 tax return and report the distributions from the converted Roth as a taxable distribution?’
thanks
thanks
Thanks
Permalink Submitted by Alan Spross on Wed, 2010-09-08 03:07
The conversion is effective on the day you convert. For purposes of any 5 year holding requirements, it is effective on Jan 1 of the year of the conversion.
Distributions you take will be tax and penalty free as long as you do not tap earnings on the conversion unless you had Roth IRAs more than 5 years ago. But the earnings come out last, so you probably would not be tapping earnings.
Yes, if you opt out of the two year deferral and report the conversion in 2010, your quarterlies or withholding sources must be a safe harbor to avoid a penalty. One of the safe harbors is 100% of your tax liability for 2009 (110% for higher incomes).
Now if you elect to report the income in 2011 and 2012, you upset that result if you withdraw conversion dollars prior to 2012. If you take distributions of conversions in 2010, the tax for the amount you distribute in 2010 will be moved from 2012 to 2010. If you wait until 2011 to take distributions, the tax on that amount will be moved from 2012 to 2011. You won’t pay anything additional, you will just accelerate the reporting year into the year of the distributions. The estimated taxes would be due based on if you take those distributions prior to 2012. The purpose of these rules is to prevent conversions as a cash flow strategy when you plan to distribute the conversion. You end up in the same place as if you had not even converted the funds that you plan to distribute this year.
If you recharacterize all or part of the conversion, it just erases the tax bill for the portion recharacterized. If you do a full recharacterization, your taxes are as if you never converted. If you already paid the estimates, you cannot get that money back until you file in the spring. If you recharacterize after you filed for the year of conversion, you will have to amend that year’s tax return and include a statement describing your recharacterization.
Remember that since your husband is 71, he must take out his 2010 RMD prior to converting and cannot convert the RMD dollars.
Permalink Submitted by kathleen Lane on Wed, 2010-09-08 14:14
just to make sure I understand this:
I convert $300,000 in September, 2010.
[b]Withdrawals from the converted Roth account:
[/b]
I make withdrawals of $10,000 on October, $10,000 in November and $10,000 in December, 2010.
In 2011, I will make monthly withdrawals of 10,000–a total of $120,000.
All of the withdrawals are made from converted funds…not earnings from the conversion.
[b]Tax Impact:[/b]
If I report all of the conversion income of $300,000 on my 2010 tax return–no problem. I owe no additional taxes on the $30K of withdrawals we made in 2010…or the $120K in 2011.
If I wanted to report conversion income of $150K in 2011 and $150K in 2012. it gets complicated.
I would report the $30K of withdrawals as income on my 2010 tax return.
I would report the $120K of withdrawals as income on my 2011 tax return.
If this is how it works….how does this impact the $150K I would have reported as income in 2011 if I hadn’t taken withdrawals?
Is the $30K and the $120K of withdrawal income the same $150K I would have reported as conversion income in 2011 if I hadn’t taken early withdrawals? Or do you need to count the withdrawals some other way when calculating the conversion income reported in 2011 and 2012?
thanks
Permalink Submitted by Alan Spross on Wed, 2010-09-08 17:29
If you take those distributions in 2010 or 2011, no new taxes are created. You just pay your conversion taxes sooner than if you had not taken distributions.
In your specific case, the 30k distributed in 2010 would be taxable in 2010. The 120k distributed in 2011 would be taxable IN ADDITION TO the amount that would otherwise have been taxable, ie 150k. The result is 270k would be taxable in 2011. Since the total taxable in 2010 and 2011 now equals your 300k conversion, there is NOTHING taxable in 2012. Again, there is no new taxable income, but the date is moved forward. This will all be handled on the redesigned Form 8606.
But note that IF you had a Roth IRA prior to your conversion that had a balance of regular (not conversion) contributions, those contributions would come out first before your conversion amounts, and that would allow you to defer more of the conversion taxes to 2012.