Possibility of conversion of traditional IRA to Roth IRA

1. Roth IRA conversions, recharacterizations,
and reconversions
Allianz Life Insurance Company of North America
It’s been tough out there lately. Want to bring some In addition, Roth IRAs need not pay out required
good news to your clients? Down markets may make minimum distributions during the owner’s lifetime.
this a good time to convert a traditional IRA or a The owner can accumulate the funds for life if they wish,
qualified plan lump sum to a Roth IRA. Why? and leave a tax-free Roth IRA for their beneficiaries.
Because when a client converts a retirement account
Converting to a Roth IRA
to a Roth IRA, they are taxed on the value. If that value
A traditional IRA can be converted to a Roth IRA.
has fallen, so will the income taxes. And Uncle Sam
Recent law also allows a person to convert a qualified
even gives clients a chance to “do over” a conversion,
retirement plan directly to a Roth IRA without first
if values continue to fall after the original conversion.
rolling over to a traditional IRA. Of course, the client
Why a Roth IRA? must have a distributable event to take funds from
There’s a lot to like in a Roth IRA. While distributions their qualified plan – typically because of reaching 59 ½
from a traditional IRA are usually fully taxable, or separating from service. Also, the qualified plan
Roth IRAs allow for tax-free qualified distributions. must allow for the conversion directly to the Roth IRA.
And, because Roth qualified distributions are not
The client must meet two requirements to be eligible
added to income, they will not boost your client’s
to convert to a Roth IRA. First, the client’s Modified
adjusted gross income (AGI) like traditional IRA
Adjusted Gross Income (MAGI) must be less than
distributions will. A lower AGI has a ripple effect on
$100,000 (regardless of whether the client is filing
taxes. For example, a lower AGI can mean less of your
jointly, head of household, or single). MAGI is generally
client’s Social Security benefit is subject to tax. A lower
AGI, but not including the Roth conversion itself.
AGI means it will be easier to get over the 7.5%-of-AGI
The second requirement is that the client cannot have
threshold for deductible medical expenses or the 2%
the filing status of “married, filing separately.”
threshold for miscellaneous itemized deductions. The
phase-out of personal exemptions and itemized The client must include the value of the conversion
deductions is also keyed to a higher AGI. in income, and pay income tax on it. For an annuity,
the value is generally the cash value plus the actuarial
present value of any additional living or death benefits.
Qualified distributions
Note that including the conversion in income will
How does your client get a tax-free distribution
spike the AGI for the year, which might have negative
from their Roth IRA? They need to take a “qualified
distribution.” A distribution from a Roth IRA is ripple effects on taxes, as described above. If the client
tax-free if they have had a Roth IRA open for five years were to take part of the conversion funds to pay the
AND if they take the distribution after 59 ½,
taxes, it would hurt the economics of the conversion.
if they take it because of death or disability, or if they
It is best to pay the taxes from outside funds.
take up to $10,000 for a first-time home purchase.
If their distribution is not a qualified distribution,
then see our Q & A referenced below for an
explanation of the rather complicated tax scheme.
AMK-223 For financial professional use only – not for use with the public. (11/2008)
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2. Reconversion
2010: Roths available for more people Suppose Fay still likes the idea of a Roth conversion,
Roth IRAs will continue to be a hot topic for 2009 and but she just doesn’t want to pay tax on value that
2010. That’s because Congress recently passed a law
disappeared. After she does the recharacterization,
to lift the obstacles for converting to a Roth IRA.
Fay can reconvert to a Roth IRA a second time.
Beginning in 2010, even people with MAGIs above
The taxpayer who wants to reconvert will have to wait
$100,000 or people who are married, filing separately
until the next calendar year after the original
will be able to convert to a Roth IRA. In addition, if they
convert in the year 2010 (only 2010), they can defer conversion or, if later, 30 days after the recharacterization
taxes for a year and then spread the tax over tax years to reconvert. So someone who converts in May 2008
2011 and 2012. Spreading the taxes could potentially
and recharacterizes in February 2009 has satisfied the
reduce their overall tax rate on the conversion. If you
“calendar year after the original conversion” test, and
have a client who wants to convert to a Roth IRA but is
now must wait until 30 days after the recharacterization.
ineligible, plan for a 2010 (or later) conversion.
Someone who converts in May 2008 and recharacterizes
Have them save now to make sure they have the
liquidity to pay the taxes without having to dip into the in October 2008 has to wait at least until 2009 to
converted funds. reconvert. Hopefully, the risk will pay off and the value
will stay low until the reconversion.
Recharacterization
What happens if your client converts today but the
Roth IRAs for the wealthy
value of the Roth IRA falls? They will have paid tax on
Roth IRAs may be especially attractive to wealthy
money that disappears. For example, suppose Fay clients with taxable estates. A Roth IRA owner doesn’t
converted her traditional IRA to a Roth IRA in February have to take any RMDs during their lifetime. They can
save the entire IRA for their children or grandchildren.
2008 when its value was $50,000. She has to include
It also helps in estate planning. A wealthy Roth IRA
that $50,000 in income tax. But then the credit crunch
owner pays the income tax when they convert. This is
hit Wall Street, and now her IRA is worth only $30,000.
a real economic benefit to the children or grandchildren
She doesn’t want to pay tax on $50,000 when the value
who will inherit the qualified distributions from the
today is only $30,000. Fortunately, Uncle Sam will allow Roth IRA, because it cuts their future tax burden.
her to undo the transaction. Yet paying the tax is not considered a taxable gift to
the beneficiaries and will not use any of the parent’s
Your client can “recharacterize” a Roth conversion $2,000,000 ($3,500,000 in 2009) estate and gift tax
back to a traditional IRA. The recharacterization applicable exclusion amount.
treats the transaction as if the original conversion
never happened. After they recharacterize the Roth
Allianz can help
IRA to a traditional IRA, there is no need to pay tax
Roth IRA conversions are a bright spot amid the dim
on the conversion.
financial news of today. They can give you a positive
A calendar-year taxpayer can recharacterize until idea to present to your clients. Uncle Sam has taken
October 15 of the year after conversion. For example, some of the risk out, too, by allowing
if a taxpayer converted to a Roth IRA in 2008, they have recharacterizations and reconversions.
until October 15, 2009 to recharacterize that Allianz offers you several resources to help you understand
conversion back to a traditional IRA. Even if the Roth IRAs. Ask your Sales Desk representative for:
taxpayer already filed a 2008 tax return, they can Q &A Converting to a Roth IRA
recharacterize and file an amended 2008 return. Q & A Roth IRA distributions
(Both of these can be found in our Advance Markets
Q & A book, Third Edition.)
You can also speak to one of our tax specialists by calling the
Sales Desk and asking for the Advanced Sales phone line.
This document is designed to provide general information on the subjects covered. Pursuant to IRS Circular 230, it is not, however,
intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax
plan or arrangement. Please note that Allianz Life Insurance Company of North America, its affiliated companies, and their representatives
do not give legal or tax advice. Encourage your clients to consult their tax advisor or attorney.
Not FDIC insured • May lose value • No bank or credit union guarantee • Not a deposit • Not insured by any federal government agency or NCUA/NCUSIF
Allianz Life Insurance Company of North America, 5701 Golden Hills Drive, Minneapolis, MN 55416-1297. www.allianzlife.com
AMK-223 For financial professional use only – not for use with the public. (11/2008)
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