Consider Converting your Traditional IRA to a Roth IRA in 2010 – Part 3

I have a few clients that started a Roth IRA in their college or residency years, however most physicians and dentists with whom I work, do not have Roth IRA’s because the income limitations associated with Roth contributions have made it impossible for them to start one.

Recently, I have had several physician clients inquire about the possibility of converting their “Traditional IRA” account to a “Roth IRA” in 2010.   Beginning on January 1, 2010, the modified adjusted gross income limit of $100,000 that has precluded most physicians and dentists from converting  traditional IRA balances to a Roth account will be repealed.   This change in the tax law will allow affluent taxpayers the significant opportunity to move funds from a tax-deferred status to a situation where future distributions may be tax-free.

The intent of this series is to provide you with some basic strategies and information on Roth Conversions for 2010. The concepts and strategies offered here may not be right for you.  For a more specific tax analysis of your personal situation, you should schedule a consultation with your tax preparer or financial planner.

For the final post on this matter (Part 3 of 3) – let’s review a strategy where hindsight can be beneficial to making a Roth conversion work for you:

Over the years of preparing taxes for physicians and dentists, I have come across the situation where a client’s Roth contribution for the year was in excess of the allowed amount because their income for the year was too high.  Rather than withdrawing the excess contribution to avoid the potential tax and penalty consequences, I would suggest that they contact the trustee of their IRA and “re-characterize” their contribution, or portion thereof, to a traditional IRA before we filed their income tax return.  This, after-the-fact, corrective action would allow the client to keep any built up earnings in a tax deferred account rather than paying the tax consequences.For the purpose of converting your traditional IRA to a Roth IRA in 2010, utilizing a similar “re-characterization” strategy may prove beneficial to you if, in hind-sight, you determine that converting wasn’t as beneficial as you might have hoped.  Under the current tax law, a taxpayer has until October 15 of the year following the conversion date to “re-characterize”, or undo, your conversion. Let’s look at a couple examples:

Let’s say that you convert all of your traditional IRA accounts to a Roth IRA right away in 2010.  At the time of your conversion the value of your traditional IRA’s was $100,000. You would have up to October 17, 2011 to re-characterize all or a portion of your conversion.  In late summer or early fall of 2011 you check the value of your now Roth IRA and find that the market value of your account is $125,000.  In this situation, choosing to keep the 2010 conversion would make sense because you will have sheltered $25,000 of income from future income tax.

Now let’s assume the same facts as above, but in this case when you open your statement in late summer or early fall of 2011 you find that the value of your account dropped to $80,000.  If you would have known that your account was going to drop in value when you made the original conversion, you would have put off the conversion of your traditional IRA until the later date to avoid paying tax on the higher value of $100,000, right? Well, in this case, you would simply “re-characterize” the Roth conversion back to a traditional IRA before October 17, 2011 and then reconsider converting the lower value to a Roth at later date.

While the above examples present a fairly straight-forward reason for using the strategy of “re-characterizing” a Roth, your personal situation may present a whole set of different circumstances requiring further analysis.  Regardless, having the option of looking back and re-considering your decision makes the initial decision to convert from a traditional IRA to a Roth IRA a whole lot easier and less risky.

Mike DeVries is a CERTIFIED FINANCIAL PLANNER ™ and a Certified Healthcare Business Consultant focusing on helping healthcare professionals. If you would like to learn more about becoming a client of Mike’s, contact him at www.vmde.com

Please note: I reserve the right to delete comments that are offensive or off-topic.

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