Undo Roth contribution then do Roth Conversion
Early this year, I made Roth contributions for myself and for my wife for 2010. At the time, I expected to earn much less than I did this year. I no longer qualify to have made those contributions.
I’m very confused about when/how I should go about backing those out, and when/how I go about doing a conversion of IRA accounts to our Roth accounts:
1) Should I first do a re-characterization of the improperly-deposited funds to our Roth accounts in 2010?
2) Does it make any difference if I do the re-characterization of those 2010 contributions before December 31 2010 or if I do it by April 15, 2011?
3) If I also want to do conversions from our IRAs to Roths, do I do that before or after the above Roth re-characterization? Should I use the “corrected” account values when doing the conversion? Can the 2010 contributions be converted as well or do I have to remove them from the calculations?
Thanks!
[edited to change “conversions” to “contributions” in the first sentence]
Permalink Submitted by Alan Spross on Fri, 2010-12-10 16:37
It appears that you made REGULAR Roth contributions earlier, although your first sentence indicated conversions. The income limits apply only to regular contributions starting in 2010. If you will exceed the modified AGI limit, you have until 10/17/2011 to either withdraw the contributions with allocated earnings or to recharacterize them as TIRA contributions instead. As TIRA contributions, it is likely that you could not deduct them because of your income level and if one or both of you is covered by a retirement plan at work.
1) No particular order is required, but if you opt to recharacterize them as non deductible TIRA contributions, it is best to do the recharacterization now, so you will know how much of your conversion will be taxable. If you are positive that you are over the income limit, there is no benefit in waiting to recharacterize.
2) Again, this is not critical, but your tax filing and conversion planning will be easier if you do the recharacterization right away.
3) Same situation, it is not critical which you do first, but if you are doing full conversions of your TIRAs, you will need to have those recharacterized Roth contributions in the TIRA or you will have to do a second conversion in 2011.
You can convert the 2010 contributions if you recharacterize them first and still have a 2010 conversion which you can report in 2011 and 2012. Also, if you want to use the tax brackets in all 3 years, one of you can convert and defer the income while the other opts out and reports their conversion in 2010. That way, your conversion income is spread more equally over all 3 years. Then early in 2011 you can make your 2011 non deductible TIRA contributions and immediately convert them as a 2011 conversion. Those conversions would be tax free if you previously converted all your other TIRAs in 2010. The net result is that in future years you would have the same affect as a regular Roth contribution, ie make a non deductible TIRA contribution, immediately convert it to a Roth, and you then have a Roth contribution. But if you have other TIRAs or rollover IRAs, the conversions will be mostly taxable since you must pro rate over all your IRAs to determine the taxable amount of a conversion.
Permalink Submitted by David Doak on Fri, 2010-12-10 17:44
[quote=”[email protected]“]It appears that you made REGULAR Roth contributions earlier, although your first sentence indicated conversions.[/quote]
Yes, exactly. In the first sentence, “conversions” should have been “contributions.” Not sure how I managed to mistype that. Glad you were able to figure it out. I’ll see if I can edit that post so others are not confused.
[quote=”[email protected]“]The income limits apply only to regular contributions starting in 2010. If you will exceed the modified AGI limit, you have until 10/17/2011 to either withdraw the contributions with allocated earnings or to recharacterize them as TIRA contributions instead. As TIRA contributions, it is likely that you could not deduct them because of your income level and if one or both of you is covered by a retirement plan at work.
1) No particular order is required, but if you opt to recharacterize them as non deductible TIRA contributions, it is best to do the recharacterization now, so you will know how much of your conversion will be taxable. If you are positive that you are over the income limit, there is no benefit in waiting to recharacterize.
2) Again, this is not critical, but your tax filing and conversion planning will be easier if you do the recharacterization right away.
3) Same situation, it is not critical which you do first, but if you are doing full conversions of your TIRAs, you will need to have those recharacterized Roth contributions in the TIRA or you will have to do a second conversion in 2011.
You can convert the 2010 contributions if you recharacterize them first and still have a 2010 conversion which you can report in 2011 and 2012.[/quote]
So I can recharacterize the 2010 Roth contributions, and then convert them back to Roths in the same tax year? Does that mean I essentially converted TIRA contributions made in 2010, into Roths, the same year?
[quote=”[email protected]“]Also, if you want to use the tax brackets in all 3 years, one of you can convert and defer the income while the other opts out and reports their conversion in 2010. That way, your conversion income is spread more equally over all 3 years. Then early in 2011 you can make your 2011 non deductible TIRA contributions and immediately convert them as a 2011 conversion. Those conversions would be tax free if you previously converted all your other TIRAs in 2010. The net result is that in future years you would have the same affect as a regular Roth contribution, ie make a non deductible TIRA contribution, immediately convert it to a Roth, and you then have a Roth contribution. But if you have other TIRAs or rollover IRAs, the conversions will be mostly taxable since you must pro rate over all your IRAs to determine the taxable amount of a conversion.[/quote]
Great advice. Thank you very much. I have one other question related to above:
We have two very small TIRAs. We also have two, much larger IRAs from former 401k and pension rollovers. I must use these rollover IRAs in the conversion calculations, but I would not have enough cash to pay taxes to convert all of it. In this case (where I don’t convert everything), does it still make sense to make a 2011 TIRA contribution, then convert it the same year to a Roth? Thanks again!
Permalink Submitted by Alan Spross on Fri, 2010-12-10 19:08
Yes, you can recharacterize the regular contributions to TIRA contributions and then convert them in the same year. This is different than the disallowed reconversion limits under which you cannot reconvert a recharacterized amount in the same year. But your contributions were regular contributions, not recharacterized conversions.
What you have then is the following sequence in 2010:
1) Made regular Roth contributions but not eligible due to income
2) Recharacterized as traditional IRA contributions including earnings
3) Convert the TIRA contributions in addition to the conversion processed earlier. Your conversions will be added together, and reported on Form 8606, one for each spouse. On these same 8606 forms, you will report the non deductible contributions made for 2010.
You can then either split the conversion income between 2011 and 2012 or opt out and report it all in 2010. Each spouse can make a different election. Conversion recharacterization deadline and decision deadline for which year the income will reported in is 10/17/2011, but you would need to extend your 2010 return if you intend to recharacterize after April.
Your last question:
Your large rollover IRAs will make your conversions mostly taxable, pro rated over the total of each spouse’s IRA accounts. It rarely is a good idea to convert when you do not have the cash to pay the taxes from non IRA funds. But it also does not make sense to convert so much in a single year (or even split between 2011 and 2012) that you inflate your tax bracket and increase the chances that you would pay a higher rate for the conversion than you would in retirement if you just kept the TIRAs. Therefore, you should try to figure out how much you can convert and not increase your tax rate. And if you have already converted, you can of course recharacterize all or part of the conversion to back the taxable income down to what you feel works out best. Some people convert more than they need and after all their income and deductions are known, recharacterize back the amount that brings them down to the top of their current bracket. It’s some extra work, but can save dollars in the long run.
The analysis of how much to convert is subjective and difficult because many factors are potentially involved. You are guessing what your future tax brackets will be in retirement and how much future tax rates will increase. You also have to factor in taxation of your SS income and a few other factors as well.
Permalink Submitted by David Doak on Fri, 2010-12-10 19:31
I think I understand what needs to happen now.
Thank you [u]very much[/u] for your clear and detailed explanations.