Twists and turns in converting a traditional IRA to a Roth

The change of the tax laws to allow everyone to convert their traditional IRAs into ROTH IRAs in 2010 was a nice present to the tax advisor community.  The issues with this one were nearly enough to make even me, a die hard do-it-yourselfer, seek professional advice.   Instead of paying for advice, I called the IRS.  The woman I talked to in the IRA department was very helpful, seemed very credible–and contradicted some the advice of the people I talked to from Fidelity (800-FIDELITY) and Schwab (800-424-5750).

The key documents I was able to find were IRS form 8606 and its instructions, and publication 590.   My discoveries / conclusions (disclaimers apply):

  1. All the IRAs / SEP / similar accounts (see IRS for specifics) for an individual need to be summed together when considering a conversion.  You can’t convert the account using all post-tax dollars, without accounting for the pre-tax contributions you might have in another account.
  2. Even if you are married, filing jointly, point 1 applies.   You don’t have to combine the husband’s and wife’s accounts together, just all of the accounts of the person that is converting.
  3. Don’t intermingle tax year 2010 contributions in with the conversion.  Some people are claiming there is a loophole that allows 2010 contributions to be converted this year.   The IRS person I talked with said the conversion is intended for 2009 and older contributions–mixing in 2010 contributions looks like a recipe for confusion.   The IRS person suggested that the simplest approach is to zero-out the old accounts by transferring everything (the old accounts don’t need to be closed) before 2010 contributions are made.
  4. The Roth money can’t be pulled out without penalty for 5 years after it is put in–for my case anyway
  5. Both Fidelity and Schwab offer the same capabilities (e.g., option trading level capabilities) in both the traditional and Roth IRA.  Brokers aren’t consistent on this, so be sure to ask if you’re not sure if something is allowed in the IRA account.
  6. Using money from the IRA you are converting to pay taxes due to the conversion seems like a really bad idea.  For starters you will likely have to pay the 10% early withdrawal penalty.

I plan to do a total conversion, a partial conversion looks like a long term headache.

Additional resource:

  • Traditional IRA To  Roth IRA Conversion Tax Example

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