April 2010

Using a Qualified Plan Account to Fund a Roth IRA Conversion

From Journal of Accountancy.

Roth IRAs have become popular retirement savings options since their introduction in 1998. However, high-income individuals have not been able to take advantage of the Roth IRA opportunity. Recent tax law changes expand the Roth IRA to all taxpayers who have or could have traditional IRA accounts.

Background

Before 2010, the Internal Revenue Code limited the opportunity to convert a traditional individual retirement account (IRA) into a Roth IRA to individuals with adjusted gross income of less than $100,000 (not indexed). In addition, the Code prevented all individuals with a married filing separately tax filing status from electing a Roth IRA conversion, regardless of their income levels. In 2006, Congress enacted the Tax Increase Prevention and Reconciliation Act (TIPRA, PL 109-222), which prospectively repealed (effective Jan. 1, 2010) both the $100,000 income limit for conversions and the restrictions applicable to taxpayers who are married filing separately. Therefore, as of Jan. 1, 2010, all taxpayers are eligible to convert a regular IRA to a Roth IRA regardless of their filing status or income level.

The Roth Advantage

Unlike traditional IRA accounts, qualified distributions of the earnings in a Roth IRA account are free from federal income tax (see IRC § 408A(d)). In addition, Roth IRA accounts are, during the IRA owner’s lifetime, not subject to the required minimum distribution rules of section 401(a)(9)(A) (see section 408A(c)(5)). A spousal beneficiary of a Roth IRA can continue to defer the distribution of the account (see section 401(a)(9)(B)(iv)). Nonspousal beneficiaries of a Roth IRA will have to begin distributions after the participant’s death (see section 408A(c)(5)). The price a taxpayer pays for the tax-free distribution and the extended period of tax-free buildup of assets is that the taxpayer must fund current-year Roth IRA contributions with after-tax money and must pay tax on Roth IRA conversion transactions.

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