Convert to a Roth IRA for Free?

Do you want to convert your IRA to a Roth but think it will cost to much in taxes? Maybe not – read on!

Much has been written about converting your IRA to a Roth IRA in 2010. Even though this option to convert continues into the future for everyone the furor over the conversions in 2010 stems from the fact that the tax from the conversion does not need to be paid on the 2010 return but can instead be spread out and paid half in 2011 and the rest in 2012. This spreading option is not available for conversions after 2010. This ability to spread out the tax effect of the conversion is significant, however you may be able to do one better and convert for free! First determine if you have losses or losses carrying forward to 2010, abnormally high medical expenses or even unused charitable contribution carry-forwards in 2010. The idea is that by converting to a Roth IRA you recognize the income but use the losses, deductions or credits that might otherwise be wasted or go unused to offset the income. You now have a portion of your IRA as a Roth and you did not pay any tax on it! Unfortunately, many small business owners have experienced losses this year (and in prior years that may be carrying forward to this year) which may make this a viable strategy

It is also important to remember that the conversion to Roth is NOT an all-or-nothing proposition. It may make sense to convert only part this year to use the 2 year spreading option and then look at it again next year. It may make a lot of sense to convert enough each year to completely fill up the bracket you are in but not push yourself into a higher bracket. This method would also give you the opportunity to see if you have losses, medical expenses or charitable contributions that you can offset next year or the year after as well. By careful planning you may be able to convert to a Roth with little or no tax cost! Keep in mind too that if the value of the Roth IRA falls between now and next October (assuming you extend to next October), you can undo the conversion and move the money back into the traditional IRA. That lets you avoid paying tax on money that has disappeared.
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