Roth IRA Conversions

By Ward J. Wilsey, JD, LLM3655 Nobel Dr. Suite 345

San Diego, CA 92122(858) 764-2672

wardwilsey@wilseylaw.com

Ward J. Wilsey, JD, LLM

BA in Economics from UCSDJD from University of San DiegoLLM in Taxation from Washington

University in St. LouisEstate Planning Attorney with the Wilsey

Law FirmFrequent lecturer with several providers of

continuing legal education for attorneys, including the National Business Institute

Roth IRA OverviewRoth IRAs are treated exactly like regular

IRAsExcept for where the Internal Revenue Code

specifiesThree main advantages

Distributions are Tax FreeNo Required Minimum Distributions (“RMDs”)No Maximum Age for Making Contributions

DisadvantageCannot Deduct Contributions

Minimum Distributions Rules for RothsNo Lifetime Required Distributions

408A(C)(5)Post-Death RMD rules do apply

Reg. § 1.408A-6, A-14(b)Roth distributions and conversions do not

fulfill MRD requirements for a traditional IRAReg. § 1.408A-6, A-15

Roth DistributionsQualified Distributions are Tax Free if they

meet two requirements:Five Years after first contribution

§ 408A(d)(2)(B)And one (or more) requirements of § 408A(d)

(2)(A) are met:After Age 59.5After Participants deathAttributable to Participant being disabled

Ways to Fund Roth IRARegular Contributions

Less of Contribution or the applicable dollar limit§ 408A(C)(2)Less Traditional IRA Contributions

Applicable Dollar LimitYear Dollar Limit Add on Over

50

2002-2004 $3,000 $500

2005 $4,000 $500

2006-2007 $4,000 $1,000

2008-2010 $5,000 $1,000

Income Limits for Contributions2009

Single Income Limit of $105,000 MAGIPhase-out to $120,000

Married Income Limit of $166,000 MAGIPhase-out to $176,000

Basically no contributions for Married filing separately

Rollover Roth IRATransfer Funds from Traditional IRA

Amount includible in gross income§ 408A(d)(3)(A)-(C)

Three Ways (§408(d)(3)(A)(i))Cash from Traditional contributed to Roth

within 60 DaysPlan to Plan Rollover Re-designated by Custodian

Who May Convert?2009

Income Limit of $100,000No age requirement

Watch out for paying taxes with IRA if under age 59.5, 10% early withdrawal penalty

MAGI (Modified Adjusted Gross Income) (See generally §219)Start with Adjusted Gross Income

Certain income normally excluded in added in and certain deductions are not allowed

i.e. IRA Contributions

Who May Convert2010

Anyone may convert, no income limitsMay pay the taxes over two years

½ 2011½ 2012

Mathematics of a ConversionExample

Joe has $500,000 IRA growing at 8%$500,000 of non-qualified liquid assets

growing at 6%Difference in growth rates used to reflect

lack of income taxes affecting IRA growthAge 50

Convert or no Convert???

Comparison in 2030

Conversion No Conversion Joe converts $500,000 IRA

to Roth IRA and pays the taxes with Non-IRA assetsTaxes of $225,000 state

and federal After in 2010

Roth IRA worth $500,000 growing at 8%

Liquid Assets now worth $275,000 6%

In 2030Roth IRA worth

$2,330,478Non-Qualified worth

$881,962Total is $3,212,440

Joe doesn’t convertAfter in 2010

Roth IRA worth $500,000 growing at 8%

Liquid Assets now worth $500,000 6%

In 2030Roth IRA worth

$2,330,478Non-Qualified worth

$1,603,567Total is $3,934,046

Increase reflects built in Capital Gains Tax Liability

ConversionThese are almost equal accounting for

taxesThe big deal is if taxes raise in the future,

since distributions will be taxed at a higher taxAlthough the conversion is a bust from the

IRA owners perspective if tax rates lower in the future

Comparison in 2050

Conversion Non-Conversion

IRA $10,862,260Non-Qualified

$2,828,572Total of

$13,690,833

IRA $3,777,396Non-Qualified of

$5,142,858Reinvested RMDs

(now non-qualified of $4,020,364)

Total of $12,940,620Decrease reflects

that taxes were paid on RMDs

Beneficiary 50 Year Old

Conversion Non-ConversionIRA worth $10,862,260By age 85, the

Beneficiary will have $60,097,460 in distributions

$2,828,572 in non-qualified assetsAssume all growth and

income is distributed$11,180,310 by age 85

$71,277,770 total

IRA worth $3,777,396By age 85, the

Beneficiary will have $11,494,527 in distributions

$5,695,259 in non-qualified assetsAssume all growth

and income is distributed$18,110,433 by age 85

$29,604,960 total

Bottom LineIf Conversion Occurs, Inherited Roth IRA is

far preferableIf wealthy clients have IRA or 401K that

they don’t need, and have sufficient liquid funds for conversion, they should probably do it

Roth Conversion Option 3Conversion occurs after clients deathInternal Revenue Notice 2008‐30 allows for

a Roth Conversion to occur after a clients death

Make sure the numbers workYou are using Non-Qualified Assets to pay

taxesLife Insurance???

Keep In MindFor Estate Planning Purposes:

Best Scenario is Roth Conversion during lifetime

Second Best is No ConversionRoth Conversion after Death???