Thursday, January 7, 2010


This post has nothing to do with religion.

One of the free online tax newsletters I regularly receive is TAX PRO NEWS, written by Bob Jennings, of Jennings Seminars.

The December “ROTH IRA Special” issue points out that - “In the next few weeks Americans will be inundated with a media onslaught recommending that they convert, convert, and convert to Roth IRAs”, and reminds us of some important items that one should consider before, and after, deciding to convert.

First you should think about how you are going to pay for the conversion (highlight is mine) -

If the taxpayer takes money out of their IRA to pay the tax, then it is treated just like any other IRA withdrawal, meaning if the converting taxpayer is under age 59 and ½ a 10% penalty will apply on any conversion money used to pay tax rather than converted to the Roth!. Similarly if money is withdrawn from the Roth to pay the tax, that money has not been in the account for 5 years and will also be subject to a 10% early withdrawal penalty unless the taxpayer is over age 59 and ½! Meaning that the taxpayer had better have some separate cash available outside of retirement accounts to pay any tax arising from the conversion.”

If you do decide to convert, when should you report the taxable income and pay the tax?

With the distinct possibility that the future rates will be substantially higher than 2010 rates, the taxpayer may wish to pay ALL of the tax in 2010. The nice thing is the decision will not have to be made until April 15, 2011.”

He warns those who convert not to “co-mingle” the conversion monies with an existing ROTH account. Keep the conversion amount is a separate account.

First, if the converted assets decline in value the taxpayer may wish to re-characterize back to the traditional IRA, and this may be impossible once the funds are co-mingled.

More importantly, converted money uses its own 5-year holding period. This means that co-mingled contributory/converted Roth IRAs will use the new conversion date to calculate the beginning of the 5 year holding period, rather than the old contributory date. This could be disastrous for an individual planning on utilizing the old contributory Roth accounts in the near future!

And Bob says not to refuse to think about the unthinkable, telling us what his mother said when he told her she had to pay some tax on her Social Security benefits - “President Roosevelt said we would never have to pay tax on Social Security.” He is correct when he suggests -

Do you really believe our current crop of spine-free politicians will ever actually cut funding to anything when there is a several trillion dollar pool of never-to-be-taxed Roth IRAs just waiting there ready to be taxed?

You can click here to subscribe to TAX PRO NEWS and to read past issues.

There are also some good free downloads available on the Jennings Seminars website.

Robert Powell also gives some good advice (often repeating what Jennings has said) in his article “Roth It Right: Six mistakes to avoid when converting to a Roth IRA” at MARKETWATCH.

Speaking of the ROTH conversion, I discussed a potential problem with the issue in the post “The ROTH Conversion Trap”.