Converting IRA + 401K to Roth in 2010
I understand that in 2010 traditional IRA rollovers to a Roth IRA must be reported either as income in 2010 or split 50/50 as income for 2011 and 2012. The choice of taxable year in which the income is reported must be the same for all of a taxpayer’s IRA conversions in 2010. I am 63 years old and retired. In 2010 I converted a traditional IRA to a Roth IRA with the intention of splitting the income over 2011 and 2012. In 2010, can I also convert a portion of my 401K to a Roth IRA but report the income in 2010, or am I restricted to the same choice I have made for my traditional IRA conversion? Alternatively, can I take a cash distribution from my 401K, report that income in 2010, even though I opt to spread my traditional IRA distribution over 2011 and 2012? I want to spread income over 3 years, because I am a NY resident, and NY gives a $20,000 exemption per person for pension and IRA distributions, and I don’t want to forfeit the NY exemption in 2010.
Sam
Permalink Submitted by Alan Spross on Wed, 2010-08-11 02:52
You are restricted to the same income reporting election for 2010 conversions, whether from an IRA or from a qualified plan.
Yes, you could take a taxable distribution in 2010 that is not converted, and you must report that distribution in 2010. Only the conversions can be deferred to 2011 and 2012. But why not just opt out of the two year deferral and report your conversions each year. Unless something has changed, NYS allows the 20,000 exclusion on Roth conversions as well as distributions that are not converted. A conversion is a two part transaction – first a distribution and second a rollover to a Roth IRA. So you still have the distribution element here and you should be able to exclude 20,000 from NY income. Converting each year would also provide for your Roth conversion income for federal purposes to be spread over 3 years, instead of concentrating it in 2011 and 2012 when tax rates could be higher, particularly in 2012.
Whether you have started SS benefits yet or not will also affect your marginal tax rates for these years.
You have plenty of time to make your final decision, since the deadline for recharacterization AND for opting out of the two year deferral is 10/17/2011. All you really have to do this year is to convert AT LEAST the minimum amount you would want, whether you opt out or not. For example, if you wanted 100,000 in total conversions over the 3 years, then convert 100k. If you defer, that is 50 in 2011 and 2012. But if you decide to go year by year, you could just recharacterize 67,000 by 10/2011 and opt out of the deferral. That would leave you with 33,333 converted and taxable in 2010 of which 20,000 should qualify for the NYS exclusion.
Better verify that the exclusion applies to Roth conversions in NY, but I believe it does.
Permalink Submitted by Sam Kaplan on Wed, 2010-08-11 14:47
Alan,
I appreciate your helpful response to my question. I was hoping that I could do the 3 year spread of income without resorting to a recharacterization, because I would prefer to not touch my current Roth IRA portfolio. In 2010 I will probably either take a $20K taxable distribution from my 401K or do nothing and forfeit the 2010 NY exclusion. In any case, you’ve given me the information I need to make a decision.
Thanks.
Sam
Permalink Submitted by Alan Spross on Thu, 2010-08-12 00:27
You don’t HAVE to do any recharacterizations. It is just an option that is available to you if your plans change or something goes haywire.
You could simply convert year by year, just as you would have prior to the 2010 rules. That would provide you with the NY exclusion in each year. You just would not get the two year deferral for your federal taxes or for amounts in excess of 20k in NY. You would pay taxes year by year as in the past. Unless there is some other reason to recharacterize, you could avoid that.
Permalink Submitted by Sam Kaplan on Thu, 2010-08-12 15:25
Alan, I understand your point. However, I have already done a conversion of an amount of money that I had planned to split 50/50 as income for 2011 and 2012. This converted amount is twice what I would be willing to claim in 2010, so that if I were to convert and pay year by year, I would have to recharacterize about half of my conversion.
Permalink Submitted by Alan Spross on Thu, 2010-08-12 18:13
Correct. Since you already converted the larger amount, you would have to recharacterize 2/3 of it if you decided to convert over all 3 years instead and still end up with the same total amount converted.
And IF you planned to recharacterize, your decision on how much should also be affected by the earnings on your conversion. If you had a large loss, you would probably recharacterize the whole thing, but if you had compelling gains, you would tend to recharacterize less or not at all.
Example: Conversion of 100,000 now worth 135,000. If the marginal rate on the conversion is 28%, the gains on that conversion reduce the effective tax rate to 20.7% assuming those gains are not lost when the funds are eventually distributed. With the lower rate, you might decide to let the full conversion stand, and if you are uneasy about that you could always change the investments to stable value investments and lock in those gains.
Plenty of options and over a year until you must make a final decision. Granted, recharacterizations can lead to extended or amended returns if done after the initial filing date.