In 2010 there will be many changes made to the conversion rules from a traditional IRA contract to Roth IRA contract. Here are 5 facts you need to know to help your clients make informed decisions about converting:

1. New rules will allow more people to convert beginning in 2010. Currently, you cannot convert to a Roth IRA if your modified adjusted gross income (MAGI) is more than $100,000 or if you are married, filing separately. Beginning in 2010, those restrictions will be lifted. Anyone will be able to convert a traditional to a Roth IRA. This will open up a whole market of clients who have never been eligible to convert to a Roth IRA before.
   
   
2. Converting a traditional IRA to a Roth IRA is a taxable event and could result in additional impact to your clients personal tax situation, including the taxation of current social security benefit payments. However, there’s an advantage to converting in 2010. A person who converts in 2010 can elect to either 1) include the entire conversion in 2010 taxes, or 2) defer for 2010 and include half in 2011 income and half in 2012 income. For example, if your client converts a $60,000 traditional IRA to a Roth IRA in 2010, they can elect to add $60,000 to income on their 2010 tax return or include $30,000 in income on their 2011 tax return and $30,000 in income on their 2012 tax return. The correct choice requires some prognostication on the client’s part. You may come out ahead tax-wise if you defer taxes for a year and then average down over two years. However, if tax rates increase in 2011 and 2012, or if the client’s income is low in 2010, it is possible the client will be better off including all in their income in 2010. It is important to understand that for IRAs converted to a Roth IRA in 2010 the taxes due as a result of the conversion may be paid at the time of conversion, or spread out over two years after the conversion. It is also important to note that the taxes due will be based upon the tax rates in effect at the time of payment, and tax rates may be higher or lower than those in effect at the time of the conversion. The client should discuss this election with their tax advisor.
   
   
3. Understand how an annuity is valued when converting. When you convert a traditional IRA annuity to a Roth annuity, the value used to calculate the amount included in income uses the “entire interest rule.” This value is the cash value of the annuity plus the actuarial present value of additional benefits. For example, contracts that have certain living or death benefit features will be taken into account when calculating the actuarial present value of additional benefits. You will not be able to calculate this value yourself. The actuaries of the annuity company will provide this value to you.
   
   
4. Avoid the penalty for underwithholding. Suppose your client elects to pay the tax on their 2010 conversion in 2010. If your client waits until they file their tax return to pay the tax on the conversion, they might incur a penalty for failing to withhold enough tax. Your client may want to increase their withholding (such as wage withholding) or file estimated taxes quarterly throughout 2010 so that they have prepaid at least 90% of their tax bill or at least as much as the prior year’s. Otherwise, they might be subject to a penalty for underwithholding. Please be aware if your client withholds federal and or state taxes from their Roth IRA conversions, the amount withheld will be subject to the IRS 10% premature distribution penalty tax, unless an exception applies. Your client may want to discuss this with their tax advisor. Also, it is generally preferable that an individual pay the taxes due upon the conversion from funds outside of the IRA. If an individual elects to take a distribution from the IRA to pay taxes caused by the conversion, please keep in mind the potential consequences, such as an assortment of product surrender charges or IRS penalties for premature distribution.
   
   
5. If your client converts from a traditional, SEP or SIMPLE IRA to a Roth IRA, they must fill out Part II of the IRS Form 8606 and file it with their taxes.
   
   Roth IRAs are attractive because qualified distributions are income tax free, and there are no Required Minimum Distributions, during the owner’s lifetime.
   
   Your clients may be asking you questions about Roth IRA conversions beginning in 2010. Know the ins and outs so you can help clients understand their choices.

Look for our last installment of Roth information next week when will look at the process of converting an Allianz IRA annuity to a Roth IRA.