How is Roth Conversion taxed in 2010?
I want to continue to Roth my 403b over time. However, in 2009 I did not find a suitable replacement. If one is found this year, how will it be taxed? Assume $100,000.
I want to continue to Roth my 403b over time. However, in 2009 I did not find a suitable replacement. If one is found this year, how will it be taxed? Assume $100,000.
Permalink Submitted by Alan Spross on Sat, 2010-01-09 04:45
First, you must be separated from service or be 59.5 to qualify for distributions from the 403b. If that is the case, and your plan is fully pre tax, then any conversion will be fully taxable at your marginal rate. You may be better off rolling it over to an IRA and then converting in smaller increments to avoid inflating your tax bracket.
Since 2010 conversions can be reported equally in 2011 and 2012, that split will help somewhat.
Permalink Submitted by Bunny Keller on Sat, 2010-01-09 15:34
I am a bit confused by your answer. I have already converted a substantial portion of my 403b to a Roth in the final days of 2008. I had paid the RMD that year based on my 2007 12/31/07 balance, and additonally paid the taxes due on the conversion and resulting in a high AGI by April 15th of 2009. I did no conversion nor accepted a RMD for 2009 tax year. Now in 2010, I would like to do an additional partial conversion of the 403b remaining. I know I must pay tax on the 2010 RMD based on 12/31/09 before the conversion is allowed. Specifically my question is this: When is the amount of tax due from the conversion I plan to do in 2010 taxed? (Is it one half by April 15th of 2011 and one half by April 15th of 2012)
Permalink Submitted by Alan Spross on Sat, 2010-01-09 18:56
You have a choice on when to report the taxable income for conversions done in 2010 only. The default option is that half the income is reported in 2011 and half in 2012. All taxes would therefore be due on 4/15/2012 for 2011 income and 4/15/2013 for 2012 income. However, you also must meet one of the safe harbors to avoid underpayment penalties through withholding and/or estimates. It is not a good idea to have taxes withheld on your conversion, and therefore you would probably use quarterly estimates equal to your prior year tax liability (or 110% of it for higher incomes). While that would eliminate a penalty, you still might well have to come up with additional taxes in April if you do a large conversion.
You also have the option to “opt out” of the default deferral to 2011 and 2012 by electing to report your entire conversion in 2010. You might do that if you are converting nominal amounts each year OR if you are concerned about tax rates increasing in 2011 and 2012. In this case, your estimates paid in 2010 must equal your 2009 tax liability to avoid penalty OR 90% of your 2010 tax liability. The underpayment interest rate is only 4% at this time.
You cannot split your 2010 conversion income in any other way than one of the two options above.
It appears that you are aware that you always must take your RMD first before doing any conversions and you cannot convert any part of the RMD. Conversions will eventually reduce your RMDs by reducing the year end balance in your 403b on which the RMD is based.
If you had pre 1987 accruals in your 403b for which RMDs did not need to start until age 75, conversions to a Roth IRA are deemed to come from the pre 1987 accrual balance first, and that would likely eliminate the option of deferring some of your RMD to age 75.
Finally, you also have the option to reverse any conversions you do up to the extended due date of 10/17/2011 for 2010 conversions. So if you convert too much or your conversion loses money, you can recharacterize all or part of your converted amount.
Hope this answers your question, if not please advise.
Permalink Submitted by Bunny Keller on Mon, 2010-01-11 16:04
Thank you for your help. You have been great with timely and expert answers. One more follow up question. Because I did not take an RMD in 2009, do I skip my age 77 and multiplier 21.2. In other words, if I do a 403b partial conversion to a Roth in 2010, do I use age 78 and multiplier 20.3 for determining my 2009 December 31 balance for this year’s RMD (2010) which must be taken prior to the conversion? (Yes, I will turn 78 in March.)
Permalink Submitted by Alan Spross on Mon, 2010-01-11 16:17
Yes, your divisor for 2010 is 20.3.
You should continue to use your actual age attained for each year’s RMD. The waiver of the 2009 RMD does not result in a permanent one year age setback for future years.
The RMD income is fully reported in 2010. Only the conversion income can be deferred for two years. But as you do these conversions your account balance will drop each year and result in reductions of future RMDs. So when you report the conversion income in 2011 and 2012, you will have a lower amount of RMD income to be added to the conversion taxable income.