Part 1 of this blog post introduced a 5-step Roth IRA conversion strategy for individuals 45 to 60 years old who either own a sizeable traditional IRA or have the opportunity to roll over a sizeable 401(k) plan or other retirement plan to an IRA. This post presents steps 1 and 2 of this strategy, with steps 3 and 4 to be discussed in Part 3, and step 5 to be presented in Part 4 together with a hypothetical case to illustrate the use of this strategy.
Step 1 – Begin Your Plan in 2010 Using a Larger Conversion Amount Than in Subsequent Years
I’m recommending that you begin your Roth IRA conversion strategy in 2010 to take advantage of the one-time opportunity to defer 50% of the income from your 2010 conversion to 2011 and 50% to 2012 or, alternatively, take advantage of lower income tax rates in 2010 if you elect to include the income from your 2010 conversion on your 2010 federal income tax return if this makes more sense for you (see In Which Tax Year(s) Should You include Your 2010 Roth IRA Conversion Income – Parts 1, 2, and 3).
Given this unique tax planning opportunity, it will make sense in most cases to convert a larger portion of your traditional IRA to a Roth IRA in 2010 than in future years. I generally recommend to my clients a 2010 conversion amount of approximately 2-1/2 to 4 times the size of the annual subsequent year conversion amounts per Step 3 (See Part 3 next week), depending upon their current IRA value, the cost basis of their IRA, future planned IRA contribution amounts, and the total number of years over which conversions will be made.
Furthermore, if you will be doing a larger Roth IRA conversion in 2010, per my blog post two weeks ago (Be on the Lookout for Roth IRA Conversion Opportunities), it’s prudent to execute your conversion(s) following market declines whenever possible in order to convert the largest amount of your traditional IRA with the least amount of income tax liability.
Step 2 – Skip 2011 and 2012 If You Deferred the Taxation of Your 2010 Roth IRA Conversion Income
Assuming that you converted, or will convert, a sizeable portion of your traditional IRA to a Roth IRA in 2010 and will defer the taxation of your 2010 conversion to 2011 and 2012, with some exceptions, it probably won’t make sense in most situations to do any additional Roth IRA conversions in 2011 and 2012. Unless you have some significant tax sheltering opportunity, e.g., sale of rental property resulting in a large passive activity loss with minimal capital gains, net operating loss, large charitable contribution deduction from establishment and funding of a charitable remainder trust, etc., you should plan on skipping 2011 and 2012 Roth IRA conversions in order to avoid adding yet another layer of income onto your already bloated 2011 and 2012 taxable income.
So you know what to do for the next three years. What’s the plan after 2012? Stay tuned for Steps 3 and 4 in Part 3 next week.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.