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The Pro-Rata Rule for Roth Conversions

Posted by Cheryl Costa  February 9, 2010 09:32 AM

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2010 will likely be a big year for Roth conversions now that the income limit for making a conversion has been lifted.  However, there are lots of "fine points" when it comes to executing the conversion so you should definitely seek professional assistance when trying to determine whether or how much to convert. 

One important myth to dispel is that it is not possible to convert only your non-deductible IRA assets -- and that is true even if your non-deductible contributions are segregated in a separate account.  When determining the taxable portion of any amount converted, you must take a ratio.  For example, if you have $30,000 in non-deductible contributions to an IRA and you have $300,000 in total IRA assets, only 10 percent of the amount converted will be tax free.

And one other important consideration -- for a 2010 conversion, the total value of your IRA assets needs to be calculated as of December 31, 2010.  That means that you won't be absolutely sure of the percentage that will be taxable until after the close of the year. 

It also means that even if you have only a single IRA which consists of only non-deductible contributions you can't do a conversion today and then do a 401(k) to IRA rollover later in the year because any amount you rollover (even if it is after the conversion process) will "count" and therefore change your exclusion ratio.

As an aside, I would say to be careful not to get caught up in all the Roth conversion hype. Everything you read these days seems to say that converting is a great strategy for everyone.  Conversions can certainly be valuable for many people but the decision to convert is very personal.  For example, high wage earners often think they should do a Roth conversion in 2010 because they are finally "allowed to".  However, these individuals are often in very high marginal tax brackets.  In many instances, it doesn't make sense for these individuals to convert IRA assets at a 35% marginal tax bracket because their tax bracket in retirement may be significantly lower.

 

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Local finance professionals share insights and advice on issues such as budgeting, managing debt, and retirement planning.

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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
Odysseas Papadimitriou is the founder of CardHub.com, a credit card and gift card marketplace, and WalletHub.com, a personal finance site. He has more than 13 years of experience in the personal finance industry, and previously served as senior director at Capital One.

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