Larger Withdrawals From IRAs in 2010 May Help Savers With Taxes

Bloomberg

By Danielle Kucera - Oct 20, 2010 11:01 PM CT
For U.S. taxpayers making mandatory withdrawals from an individual retirement account, 2010 may be a good year to take out more than necessary because tax rates may rise. …
Savers who may be in a higher tax bracket next year should consider withdrawing more than the minimum in 2010, said Mark Nash, a partner in the Dallas office of the New York-based Private Company Services practice of accounting and advisory firm PwC. Required withdrawals are based on a formula of the account balance and the individual’s age.
“Pulling out a large sum in 2010 would lessen the 2011 amount, and make that year’s distribution lower,” said Nash, who advises high net-worth investors. …
The U.S. government suspended required minimum distributions for tax year 2009 in response to plummeting account balances after the Standard & Poor’s 500 Index dropped 38 percent in 2008. Mandatory distributions returned in 2010 as the economy strengthened and the S&P 500 rose 23 percent in 2009. Roth IRAs, which are funded with post-tax dollars, are exempt from minimum withdrawal rules while the owner is alive.

Rising Rates

President Barack Obama has proposed allowing the top two marginal income tax rates to rise to 39.6 percent and 36 percent from 35 percent and 33 percent for individuals earning more than $200,000 and couples making more than $250,000. Congress is scheduled to take up taxes when it returns from recess in November.
“This uncertainty doesn’t mean that people shouldn’t be sitting down and doing their planning now,” said Greg Rosica, a tax partner at consulting firm Ernst & Young LLP in Tampa, Florida, and contributing author to the Ernst & Young Tax Guide.
Someone who may be in a lower tax bracket in 2010 because of large deductions or less income should also consider taking a bigger distribution this year to take advantage of lower rates, said Rebecca Pavese, an accountant at Palisades Hudson Financial Group’s national tax practice in Atlanta.

Combine Withdrawals

Taxpayers who aren’t already taxed at top rates should make sure taking a bigger distribution won’t tip them into a higher bracket, said Bill Fleming, a managing director in the Hartford, Connecticut, office of PwC. …
Those who pay estimated taxes during the year can request the account administrator to withhold money from their RMDs and pay income tax just once at the year’s end, said Rosica of Ernst & Young. That way they can hold onto their money longer and invest it without paying a penalty for underpayment, Pavese said.
The law assumes that payments are made equally throughout the year unless the taxpayer states otherwise, according to the IRS.

Charity Deduction

… Any IRA account holder can give all or part of a distribution to charity and take a deduction for the donation, said Debbie Cox, a Dallas, Texas-based wealth adviser for J.P. Morgan Private Bank, which is based in New York. A provision that allowed taxpayers to roll over a distribution directly to a charity and avoid income tax expired at the end of 2009, she said.
IRA holders should also try to take their required withdrawals at roughly the same time every year to avoid mistakes or forgetting about it, Fleming, of PwC, said.
To contact the reporter on this story: Danielle Kucera in New York at dkucera6@bloomberg.net.
To contact the editor responsible for this story: Rick Levinson at rlevinson2@bloomberg.net.

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Ten IRA Tasks To Do Before The Year Ends

Financial Advisor Magazine 
…Despite what might seem like paltry balances, IRAs in the aggregate "are an incredibly important piece of the retirement puzzle, since they hold the largest single share of the $13 trillion in U.S. retirement assets," Craig Copeland, senior research associate at EBRI and author of the study, said in a release.

Your IRA, your own piece of the retirement puzzle, whether paltry or not, requires some tender loving care, especially during the last few months of the year. Here's a list of what you might need to do before 2011.

1. Take your required minimum distribution
Make sure all RMDs are taken for the year.

"Look at all owned IRA accounts and employer plans for individuals age 70 1/2 or older this year, as well as at inherited IRAs, employer plans and Roth IRAs," said Beverly DeVeny, an IRA technical consultant with Ed Slott and Company.

"Beneficiaries, no matter what their age, must take distributions from all inherited accounts beginning in the year after the death of the account owner," she said, adding that inherited accounts must be split before year end so beneficiaries can use their own life expectancies to calculate their RMDs.

Speaking of distributions, take any 72(t) distributions that are required for 2010. "If you fail to do this, you will pay penalty and interest retroactively to the first year you started taking these distributions," said Edward J. Lustberg, a certified public accountant.

2. Check for excess contributions
It might seem unlikely, given that the average IRA contribution is $3,798, but it's possible that you contributed too much to your IRA during the year. If so, remove any excess contributions before year end. You will be charged a 6% penalty for excess contributions, said Lustberg.

The maximum amount of an annual IRA contribution for a specified tax year, and whether or not your contribution is tax deductible, varies depending on a number of factors related to eligibility rules, according to Fidelity Investments. In 2009, the maximum allowable contribution to an IRA is the lesser of 100% of eligible compensation or $5,000 in 2009, and $6,000 for those age 50 or older.

3. Is everything in place?
Take nothing for granted when it comes to your IRA. "Before year end, double check on all IRA funds that moved during the year," DeVeny said. "Make sure that IRA funds went into IRA accounts, not non-IRA accounts or Roth IRAs and be sure that Roth IRA funds went into Roth IRA accounts. Look for any unexplained distributions during the year."

4. Can you do a stretch IRA?
Check whether your IRA custodian or 401(k) plan administrator will allow for the so-called "stretch" for beneficiaries, said Ben E. Connor, an attorney with Connor Law Firm.

The stretch means that beneficiaries can use their own life expectancy for distributions. In addition, check whether the custodian or plan administrator will accept a durable power of attorney, and disclaimers.

"The answer to these questions will have substantial impact on the success of their estate plan," Connor said. (If the custodian or 401(k) plan administrator doesn't accept a durable power of attorney or disclaimer, you might consider another custodian or plan administrator.)

5. Who's your beneficiary?
Here's some well-worn but can't-be-repeated-often-enough advice: Review your beneficiary designations. Make sure there is both a primary and a contingent beneficiary named on the beneficiary designation form.
"If there is no beneficiary named, the IRA proceeds will go to the estate and lose the tax advantage of the stretch," said Connor. "If there is no contingent beneficiary, and the primary beneficiary has died and no new primary beneficiary has been named, then the assets also go to the estate with the same negative result."

Image via WikipediaIt's especially worth checking your beneficiary designations if you are divorced, recently or ever.

"Make sure your ex-spouse has been deleted as a beneficiary, unless you want them to remain as a beneficiary," said Connor. "The U.S. Supreme Court has recently ruled that the beneficiary named on the beneficiary designation form trumps divorce."

Connor also advised against naming a "living trust" as the beneficiary. "A living trust should not be the beneficiary because the living trust must qualify as a 'designated beneficiary' to receive favorable stretch and tax treatment," he said. "I find that most living trusts do not qualify, or lose their designated beneficiary status through later changes to the trust."

Make sure your custodian has a written copy of your beneficiary designations.

6. One last chance for Roth conversions
If you plan to do a Roth conversion in 2010, "the funds must leave the IRA by Dec. 31 to be reported and taxable as a 2010 distribution and conversion," DeVeny said. "The funds can then be rolled over to the Roth IRA up to 60 days after they are received by the account owner--up to March 1 if the distribution was received on Dec. 31."

Contrary to what some might believe, you do not have until April 15, 2011, to do a 2010 conversion, DeVeny said.

Here is another reason why you might want to convert some or all of your IRA to a Roth IRA: according to Connor, the Roth IRA could fund a credit shelter or by-pass trust.

"A Roth IRA is usually not subject to the trust tax rate," he said. Also, review your power of attorney to make sure the agent has authority to recharacterize the Roth, if needed, Connor said.
Remember, too, that anyone can convert their traditional IRAs to a Roth IRA in 2010 regardless of income. What's more, you can pay the taxes over two years, instead of one.

Image via Wikipedia7. Turn wealth into income
Right about now, the Social Security Administration is sending you a report that tells you how much income you will receive in today's dollars when you retire. Write down that number on a piece of paper.
Now, total up the value of all IRAs and 401(k)s in your household and multiple that number by 0.04. That number is the amount some experts say you could withdraw from your retirement in today's dollars.

Now, add that number to your Social Security benefit figure, and then subtract that amount from your income. The results are roughly the amount of money you will need from other sources--such as work, pensions, reverse mortgages, life insurance or inheritances--to enjoy a lifestyle similar to what you have today. …

8. Review your investment plan
Consider updating your investment policy statement or plan. "Make sure your asset allocation remains appropriate given your financial goals," said Michael L. Gay, a certified financial planner with Portfolio Solutions.

Also, rebalance your IRA if you haven't done so within the past year. It's best to rebalance your IRA in a holistic manner. That is, look at all your assets in all your accounts, taxable and tax-deferred.
In many cases, consider putting your fixed-income investments in your tax-deferred accounts and those investments that produce capital gains and dividend income in your taxable accounts. And while you're at it, check whether you've bought or sold any inappropriate investments in your IRA accounts.
"Since IRAs are tax-deferred vehicles, it makes no sense for them to hold 'tax-preferenced' investments such as municipal bonds …," said Gay.

Gay also suggested using your RMDs to rebalance. It could save on transaction costs.

9. Roll old 401(k)s to an IRA
If you have one or more 401(k)s sitting with former employers, consider rolling that money over to an IRA. "You'll generally get better investment choices, lower costs and more control of your investment assets," said Gay.

10. Recharacterize your Roth IRA If you converted a traditional IRA into a Roth IRA and now realize that your income taxes were higher than expected due to the conversion, or you're short money to pay the income tax or you're unwilling to pay the income tax, consider a recharacterization, DeVeny said. That is, consider putting the money in the Roth IRA back into your traditional IRA.

"This is the last year that some individuals must recharacterize," DeVeny said. "Those who have no choice are individuals who converted in 2009 and whose modified adjusted gross income exceeded $100,000 or who were married filing separate."

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Required Minimum Distribution Rules Change After This Year

401khelpcenter.com

NEW YORK, NY, December 7, 2009 -- "The 2008 tax legislation to give senior citizens a reprieve from the requirement to take 2009 required minimum distributions (RMDs) from employer-sponsored tax-qualified retirement plans and IRAs was a relief to many," says Lesli Laffie, tax analyst for the Tax & Accounting business of Thomson Reuters. "… However, there may be sound tax reasons to either take or stop taking RMDs before 2009 ends," she advises. "And, seniors who are well-off and charitably inclined may want to consider transferring up to $100,000 of IRA funds directly to charity before 2010."
The RMD Quandary
… In years other than 2009, the failure to take an RMD could trigger a 50 percent penalty on the undistributed RMD. The 2009 RMD 'holiday' is available to taxpayers who own or are beneficiaries of retirement plan accounts (generally, 401k, 403(b), or 457(b) plans), or who are traditional IRA owners or beneficiaries, or Roth IRA beneficiaries. The holiday means they can withdraw less than 100 percent of their RMDs for 2009, without incurring the penalty. The suspension without penalty applies only to RMDs otherwise required for 2009, not to RMDs for 2008 that had to be taken by April 1, 2009. Taxpayers who turned 70 1/2 in 2009 still must take an RMD by Dec. 31, 2010.
"There are a number of issues to bear in mind when deciding whether or not to withdraw in 2009," says Laffie. "For those who have inherited Roth IRAs, withdrawals are tax free, so the only decision for those beneficiaries is whether to leave or withdraw account assets."
Consider taking RMDs before 2009 ends if:

• Your tax rate may be lower in 2009 than in 2010. … Rates are always subject to change, "but if a taxpayer believes he will be in a higher tax bracket in 2010 (due to higher income and/or fewer deductions), he may want to take RMDs in 2009 to incur tax at the lower rate," advises Laffie. In addition, a 2009 RMD would lessen the amount of future RMDs. "If a taxpayer anticipates that tax rates will go up in the future, acceleration of RMDs into 2009 may be an appropriate strategy."
• You have offsetting deductions. Taxpayers with high 2009 deductions relative to income, such as medical expenses, may be able to offset an RMD, but will lose the part of the medical deduction that equals 7.5 percent of their adjusted gross income (AGI). A taxpayer with a charitable contribution deduction carryover that will expire soon, or with a net operating loss, may also be able to offset the increase in income from an RMD.
• You receive social security. A taxpayer whose Modified AGI (MAGI) is below the level requiring taxability of social security payments should consider taking an RMD to the extent those payments will continue to escape taxation…
• You decide to roll over the distribution into a Roth IRA. Because RMDs are not required for 2009, a 2009 withdrawal is not considered to be an RMD. Therefore, it can be rolled over into a Roth IRA (as long as MAGI does not exceed $100,000 or you are not married filing separately). …"In 2010, more lenient rules take effect in rolling over a traditional IRA to a Roth IRA, but they won't apply to RMDs," notes Laffie.

Consider taking the RMD holiday (i.e., suspending RMDs) for 2009 if:

• More of your social security payments will become taxable. Taxpayers receiving social security, but whose payments have not yet triggered 85 percent taxability (joint filers with MAGI under $44,000, or under $34,000 for singles and HOHs), should consider forgoing RMDs. …
• Your income is high. If taking an RMD would subject you to a phaseout of itemized deductions and/or personal exemptions, it is probably beneficial to skip the RMD.
• You have other sources of income to pay bills, and therefore do not need the RMD. …

"Skipping or taking the RMD holiday, or taking only partial RMDs, is an individual decision requiring analysis of various factors," advises Laffie. "Before 2009 ends, taxpayers should take a look at their overall tax picture and make the decision that's optimal for them."
Donating IRA Funds to Charity
Until the end of 2009, those age 70 1/2 and older can contribute up to $100,000 from their IRAs directly to one or more charities. This transfer is not included as income on the federal tax return. But you do not get a charitable deduction, and the withdrawal does not count as an RMD because RMDs are not required for 2009.
So why consider such a donation now? "For those who are very charitably inclined, the technique may hold appeal, in part because these donors won't reach the ceiling on charitable deductions," observes Laffie. "Also, by using IRA money to make the donation, a taxpayer retains more of his other savings for his own use. In addition, because the amount transferred isn't included as income on the federal return, it won't trigger deduction and/or exemption phaseouts. Finally, it may be a good strategy for people who don't itemize, because they are not losing out on a charitable deduction."
"While the RMD holiday and the ability to transfer IRA funds directly to charities end when 2009 ends, it's possible one or both of these tax breaks could be extended into 2010 or beyond," says Laffie.
About Thomson Reuters
Thomson Reuters is the world's leading source of intelligent information for businesses and professionals. We combine industry expertise with innovative technology to deliver critical information to leading decision makers in the financial, legal, tax and accounting, healthcare and science and media markets, powered by the world's most trusted news organization. With headquarters in New York and major operations in London and Eagan, Minnesota, Thomson Reuters employs more than 50,000 people and operates in over 100 countries. Thomson Reuters shares are listed on the Toronto Stock Exchange (TSX: TRI) and New York Stock Exchange ( TRI). For more information, go to www.thomsonreuters.com.
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The Roth of Con(versions)

Tax Increase Protection and Reconciliation Act of 2005 (TIPRA)

TIPRA has a forward-looking provision regarding Roth conversions. It repealed the MAGI limit of $100,000 for 2010 and beyond on conversions. The contribution limits remain intact.
TIPRA also provided for a special tax treatment of Roth Conversions made in 2010. Unless a taxpayer elects otherwise, income from the conversion is taxed over a two-year period, beginning in 2011. So, if a taxpayer converts $100,000 of Traditional IRA money to a Roth IRA in 2010, he will add $50,000 to his tax return for the 2011 tax year, and $50,000 to his tax return for the 2012 tax year. If the taxpayer elects, he may add the entire $100,000 to his tax return for the 2010 tax year.

Cents and Sensibilities

The feasibility of a Roth Conversion depends on tax rates at the time of conversion, tax rates at the time of distribution, availability of funds to pay the taxes, expectations of portfolio growth, and likelihood of passing the account to non-spouse beneficiaries. Many of these factors are unknown; a decision needs to be made based on reasonable expectations. By evaluating the following questions, a Traditional IRA owner can to determine what the practical approach is:

1. Will tax brackets rise after 2010?
   
2. Will tax brackets remain above current rates for an extended period of time?
   
3. Do you expect the account balance to increase meaningfully during 2010?
   
4. Do you have non-retirement funds that you can use to pay the tax liability upon conversion?
   
5. Will the Roth IRA likely survive both you and your spouse?; also,
   
6. Will Congress initiate new taxes in 2010 that will be retroactive?
   
7. Will a conversion trigger Alternative Minimum Tax or other surtaxes, or will it accelerate the phase-out of deductions and exemptions?
   

The more confident the taxpayer is that the answers to questions 1-5 are "Yes" and the answers to questions 6 and 7 are "No," the more confident he can be that a conversion early in 2010 would be practicable. The taxpayer should also consult his tax advisor before committing to any conversion.

To Bifurcate or Not To Bifurcate, That Is the Question

Assuming we convert to a Roth IRA in 2010, we have a choice of when to pay taxes. For conversions that occur in 2010 only, the taxpayer may pay the tax liability by April 15^th, 2011, or they can add one-half of the converted amount to the tax return they file by April 15^th, 2012 and the other half on the tax return they file by April 15^th, 2013.
At first blush, you would think that we want to defer taxes until later. However, we are making the conversion in the first place to take advantage of the known lower tax rates currently in effect. Things are not as they seem—it is, as if, something is rotten in Denmark (or D.C.).
First off, converting to a Roth IRA becomes more advantageous if tax rates rise. Whether we pay the tax from the IRA or not, we are in essence betting that taxes will go up. Taxes are at historically low levels. Many political and economic pundits say that ballooning deficits will put pressure on the Government to raise taxes.
Secondly, the current tax law expires on December 31, 2010. Unless Congress acts, tax rates will return to 2006 levels on January 1, 2011. Tax brackets shift from the current 10%, 15%, 25%, 28%, 33%, and 35% rates to 15%, 28%, 31%, 36%, and 39.6%. Taxes on capital gains and dividends will rise, and certain credits will cease or be reduced.
Barring the unknown of Congressional action, we know the tax structure will be higher in 2011 and 2012 than it is in 2010. Unless a taxpayer knows that his taxable income will be significantly lower in the latter years, it makes sense that he pay taxes on the conversion in 2010. (As a broad supposition, if many taxpayers convert great amounts of IRA dollars and choose to pay the tax with their 2010 returns, it may ease the pressure on Congress to raise taxes in 2011 or 2012 beyond the de facto increases in place.)

Diversify, Diversify, Diversify

Investment advisors recommend that we diversify across asset classes to reduce purchasing power risk. They recommend we diversify within asset classes to reduce systematic risk. They recommend we diversify among banks and insurance companies to reduce unsystematic risk. We now have an opportunity to diversify among taxable, tax deferred and tax favored ownership to reduce income tax risk.
We know that mechanisms are in place to change taxes in the future, as they have changed over the past 100 years. Tax deferred assets such as qualified plans and IRAs are exposed to future tax risk. Taxable assets are exposed to both current tax risk and future tax risk. Roth IRAs (and their similar ownership forms such as 529 plans) are exposed to current tax risk, but avoid future tax risk—barring an outlying event such as a retroactive tax law change. As our assets accumulate in tax deferred ownership, we become over-weighted in future tax risk. Roth IRA conversions allow us to diversify this risk, just as we attempt to diversify to reduce the other risks.

What Good Hath Roth?

On May 24, 1844, Samuel P. Morse officially opened the Baltimore – Washington telegraph service by sending the message "What hath God wrought?" The telegraph led to the telephone. The telephone led to the cell phone. Following the trail of the cell phone leads to my teen-age daughter. I too lament, "What hath God wrought?"
Moving from the meta-physical and inter-personal to the financial, we can ask: "What good is a Roth IRA?" I admit that, when Roth IRAs were introduced, I thought they were a ploy to get people to pay taxes sooner rather than later. Looking more closely at the provisions and the mechanics of this ownership form has convinced me that Roth IRAs have a place in most people's retirement portfolio.

History

Roth IRAs were created by the "Taxpayer Relief Act of 1997." Under the Act, an individual may establish an IRA under which all distributions are free from federal income taxation if certain conditions are met. There is no income tax or penalty tax on distributions if the Roth IRA has been in existence for five years and the owner would qualify for a penalty-free withdrawal from a Traditional IRA—the owner attaining age 59 ½ being the most common qualification. After the five year period, contributions can be withdrawn income tax and penalty tax free even if the owner is younger than 59 ½. If a distribution is made from a Roth IRA without meeting the requirements, there is a 10% penalty tax on it plus income tax is owed on any portion that wasn't previously taxed.
One feature of a Roth IRA is that it is not subject to the Required Minimum Distribution rules as long as it's owned by the Contributor or spouse. Non-spouse beneficiaries may maintain the Roth IRA in its tax-free state, subject to a new 5-year hold and Required Minimum Distributions. A non-spousal beneficiary has to take the balance of the account within 5 years, or start lifetime payments before the end of the calendar year following the year of the contributor's death. Generally, there are no IRD issues involved. Additionally, since they bypass probate, Roth IRAs can be an efficient way of passing assets to heirs.
There is a catch to Roth IRA contributions. A married couple cannot make a contribution to a Roth IRA if their Modified Adjusted Gross Income (MAGI) is over $176,000 ($120,000 if single). A conversion of a Traditional IRA to a Roth IRA is prohibited if the taxpayer's MAGI is over $100,000 (married or single). (This limit to conversions is removed as of 1/1/2010 by TIPRA. See "The Roth of Con(versions).")

Pay Now or Pay Later?

Whether it is financially advantageous to convert to a Roth IRA or not is based on tax rates at the time of conversion and at the time of withdrawal. For comparison purposes, let us assume that a 50-year old has $100,000 in a Traditional IRA and is in the 35% marginal tax bracket. He will withdraw all of the funds in 20 years. If he converts to a Roth IRA, he will owe $35,000 in taxes, which he has available in a taxable account. Let us further assume that all accounts earn 6% annually, although the taxable account pays tax on its growth annually. He can either keep the $100,000 in the Traditional IRA and pay taxes on withdrawal, plus have $35,000 grow at an after tax rate; or, he can convert the $100,000 to a Roth IRA and pay the $35,000 in taxes now. On the day after he converts the funds he is either in a much lower (15%), lower (28%), same (35%), higher (42%), or much higher (55%) tax bracket. The table below shows the after-tax outcome of these five scenarios.

	Roth IRA	After-tax Traditional IRA + Taxable Fund
Much lower tax rate	$320,714	$272,607 + $94,650 = $367,257
Lower tax rate	$320,714	$230,914 + $81,549 = $312,463
Same tax rate	$320,714	$208,464 + $75,228 = $283,692
Higher tax rate	$320,714	$186,014 + $69,374 = $255,388
Much higher tax rate	$320,714	$144,321 + $59,632 = $203,953

For the Traditional IRA + Taxable Fund to equal or exceed the value of Roth IRA, the marginal tax bracket must drop 9% or more immediately after the conversion.
Now, let us assume that the 50-year old wants to consider a Roth conversion, but doesn't have funds to pay taxes with, other than the IRA. He will owe ordinary income taxes plus a 10% penalty tax on funds withdrawn to pay taxes. This time, we assume tax rates change some time before withdrawing everything from the Traditional IRA in 20 years. Using the assumptions above, we have the following outcomes:

	Roth IRA - Taxes	After-tax Traditional IRA
Much lower tax rate	$195,995	$272,607
Lower tax rate	$195,995	$230,914
Same tax rate	$195,995	$208,464
Higher tax rate	$195,995	$186,014
Much higher tax rate	$195,995	$144,321

Even with the 10% penalty tax, it does not take much of a tax increase to make the Roth IRA worth more. A tax increase of 4% or more makes the Roth IRA beneficial, even if taxes are withdrawn from it.
The conclusion we can draw from this analysis is that: (1) if a Traditional IRA participant has outside funds to cover the taxes, a Roth IRA Conversion is advantageous as long as tax rates do not drop more than 9% immediately after conversion; (2) if a Traditional IRA partyicipant pays for the conversion from the Traditional IRA and incurs the 10% penalty tax, the Roth IRA Conversion is still beneficial if taxes rise 4% or more by the withdrawal date. These conclusions do not necessarily apply to new contributions—we are analyzing Roth Conversions only.

Take Backs; or, A Question of Character

We have looked at a number of "what-if's." Here is another "what-if": What if an IRA owner converts an IRA early in the year and the value goes down after that. For example, on January 2^nd the owner converts a $100,000 IRA to a Roth IRA. On December 1 the Roth IRA is worth $60,000. The owner would have a tax liability on $100,000 but would get no benefit from 40% of that liability (the tax paid on the value that disappeared). Fortunately, you can "take-back" a Roth Conversion as long as it is done by the filing deadline. This process is called re-characterization. The IRA custodian will have forms that provide the proper information to perform a re-characterization acceptable to the IRS.
Let us follow the mechanics of conversion and re-characterization. The owner converts a Traditional IRA to a Roth IRA in January, 2010. (The earlier in the year that you convert the IRA, the more time you will have to take advantage of any tax planning.) On April 1, 2011, he compares the Roth IRA's value to its conversion value. If the Roth IRA is higher, he pays tax on the lower conversion amount when he files his taxes. If the Roth IRA is lower, the owner re-characterizes it back into a Traditional IRA and cancels the tax liability. Re-characterizations take two weeks or more, so the owner wants to allow time to act before he has to file, although a taxpayer can also file for an extension to file as late as October 15^th.
If the owner re-characterizes the IRA, the money is back in a Traditional IRA but he wants it in a Roth IRA. The tax law says that re-characterized money can be re-converted by the later of the start of a new tax year or 30 days. The owner initially converted the IRA in the 2010 tax year. The money was re-characterized by April 15, 2011 for the 2010 tax year. Since he is past the end of the tax year, he waits 30 days and converts the Traditional IRA to a Roth IRA on May 15, 2011. The owner will pay taxes on the IRA's value when he files his taxes for 2011. Since the value is lower than when he initially converted the IRA, he will owe less tax on the conversion.
Setting aside the politics of deciding when we want to give the Government money to use or waste, Roth IRAs are an advantageous ownership form for most persons' retirement. They are an excellent estate planning tool: the owner is not forced to dissipate a Roth IRA through Required Minimum Distributions; Roth IRAs pass outside of probate as long as the estate is not the beneficiary; and, they can maintain their tax-free status for the heirs. Congress has made provisions that make converting a Traditional IRA to a Roth IRA especially advantageous in 2010. See the article "The Roth of Con(versions)".