Last-Minute Investment Tax Tips for 2012
(#4 in a four-part series)

Roth Conversions

In 2010 the law regarding Roth Conversions changed. Since then anyone, regardless of income, can convert their Traditional IRA to a Roth IRA. This involves moving money from a Traditional IRA to a Roth IRA after paying ordinary income taxes on the conversion amount. The benefit is that once that money is in a Roth IRA it is never taxed again.

Since the removal of the income limits in 2010, we have performed many analyses for clients wondering if a Roth IRA conversion makes sense for them. More often than not the answer was no as our typical client is close to retirement age and in the upper tax brackets. Because of the tax owed on the conversion up front, a conversion is typically more beneficial to younger investors or those in lower tax brackets.

However, given that the tax year is wrapping up, it is worth checking with your tax advisor to see if you have any tax credits, exemptions, deductions, or ordinary losses (not capital losses) that may go unused this year due to insufficient income. If you do, you can use them up by doing a Roth Conversion and getting the money from your Traditional IRA (where it will be taxed as ordinary income upon distribution) to a Roth IRA (where it will never be taxed again) for free.

For example, if you have $50,000 in income for 2012 and $90,000 in ordinary losses and deductions, you can convert $40,000 of a Traditional IRA to a Roth IRA with no tax due. The $40,000 conversion counts as taxable income, but the losses and deductions are enough to completely offset it.

Of all of our year-end tax tips, Roth Conversions are far and away the most complex. When we do them for our clients, we work in conjunction with their tax advisor; you should definitely consult both your investment advisor and tax advisor before proceeding. But it’s important to get moving soon as the deadline for the conversion is December 31.