The Tax Prevention and Reconciliation Act or TIPRA allows different age groups and certain entities under the unrestricted tax brackets to convert from the traditional IRA or Individual Retirement Account to Roth IRA.
Named after its author William Roth, a Roth IRA is an Individual Retirement Account which is rumored to become a major transaction. In 2005, the TIPRA was passed became law. Provisions in this law states that taxpayers of every age and bracket may convert their traditional individual retirement accounts into a Roth IRA and can be implemented without consideration of the taxpayer’s income. Advisors will be contacting those who are interested in this arrangement.\
As of last June 2009, the US job market was at its 15-month low and lay-offs were rampant. To financial planners, this is the perfect time to start planning for retirement. The trained advisors can find ways to deal with current market trends and assist you in this aspect. This TIPRA is a perfect reason to touch-base with clients who are high-income earners. This will definitely scrutinize the old rules of retirement where many people will understandably take advantage of converting from the traditional IRA to Roth IRA.
1. When do you report the income?
Before 2010. You should report the full amount that was converted on that year’s income tax return. Just an example, under the TIPRA, when conversion was done in 2010, you don’t have to report it on your 2010 income tax return. You can include that income on your 2011 and 2012 tax returns. Now, if you converted the amount of $100,000 in 2010, you only have report the amount of $50,000 income in 2011 and $50,000 income in 2012. But if you converted in 2011, you will not be allowed to split the total tax due in two consecutive years.
2. When do you pay the taxes due after you have converted?
You must pay all taxes due on your 2011 and 2012 tax returns.
3. Is is advisable to split the income?
No, splitting the income is not required. If you think that splitting might involve a bigger tax, then you can opt out of this scheme.
4. If you decide to opt-out of the splitting arrangement, can you do it by stages or is it an all-or-nothing option?
It is an actually all-or-nothing option. However, if the worth of your account depreciates after a year then you can revert back to the Traditional IRA without having to suffer penalty.
5. If you convert to Roth IRA when there is basis in the traditional IRA but it is worth less, what happens next?
If the worth of the traditional IRA is less than the basic, then no income will accrue on the converted amount. But, if the taxpayer avails of the itemized deduction for value lost, the Roth IRA will be computed based on the value when the conversion was effected. There is also the scenario where loss cannot be applied to the conversion. The basis in the traditional IRA will be carried over making it the basis of the Roth IRA after it has been converted.
6. What is the five-year conversion rule?
There is a five-year period applicable to the amount used in converting the amounts involved. Without a formula for conversion, you will be allowed to withdraw your earnings without having to pay taxes provided that you are 59 ½ years of age and your account is five years old.
If you did a conversion and do not meet these qualifications then the amount that you converted will be taxable but you will not be charged they pretermination fee of 10%. But the conversion basis taken from from a Roth IRA account in a span of 5 years of the conversion process will be fined 10% if you have not reached 59 ½ yet.
Therefore, it is advisable to maintain a separate account for the intended conversion where you can also do some consolidation in the future without having to pay a fine.
