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Jean-Luc Bourdon
Jean-Luc Bourdon
 

Roth IRA Conversion Pop-Quiz

Are you up to speed?

April 5, 2010
by Jean-Luc Bourdon, CPA, PFS

By now, CPAs have heard much about Roth IRA conversions made widely available in 2010. Today, let’s see how much you’ve learned. Close your books and sharpen a number-two pencil for this self-graded pop quiz. The final exam is a take-home challenge that involves advising your clients with real-life situations. But don’t worry: to help you ace it, resources follow, including a cheat sheet.

True or False?

  1. Starting in 2010, there are no income limitations to make regular contributions to a Roth IRA.
  2. Roth IRA investment income is always tax-free if received after age 59.
  3. A 10 percent penalty never applies to a Roth IRA distribution if the owner is over age 59.
  4. Dividing an individual retirement account (IRA) into various IRAs, each holding a different investment asset class, before converting them to Roth IRAs is a strategy that allows taking advantage of market volatility.
  5. The deadline for a 2010 Roth conversion is April 15th 2011.
  6. The deadline to re-characterize a Roth conversion is October 15th of the following year.
  7. A client who has only made non-deductible contributions to a sole IRA can convert it to a Roth IRA and pay no taxes on the conversion of basis  earnings.
  8. The first distribution taken from any Roth IRA is considered to come from regular contributions, even if contributions were made to a different Roth IRA.
  9. An inherited IRA cannot be converted to a Roth IRA, while an inherited employer plan can be.
  10. The original owner of a Roth IRA can always choose to take the money out, but is never required to.
  11. A Roth conversion cannot be done in a year when the taxpayer has no compensation income.
  12. A traditional IRA converted to a Roth IRA with a Trustee-to-Trustee transfer automatically transfers the beneficiary designation to the Roth IRA.
  13. 13. Distributions from a Roth IRA are not counted as income for the calculation of taxes on social security benefits.
    True.
  14. Assets re-characterized can be reconverted at the later of (1) the year after the year of re-charaterization, or more than 30 days after re-characterization.

Answers

1. False. Income limitations no longer apply to conversions, but still apply to regular contributions.
2. False. A second requirement is that it is received after a five-year period beginning January 1st of the year the client first established a Roth IRA. Some exceptions apply.
3. True. Age is one of several exceptions to the 10% penalty.
4. True. The idea is to keep the accounts that go up in value and re-characterize others.
5. False. The deadline is December 31st 2010. Therefore, a conversion (unlike a contribution) cannot be evaluated when a tax return is being finalized.
6. True. A conversion can be made by December 31st, and then re-characterized (even partially) before October 15th.
7. False. Taxes are due on the conversion of earnings from non-deductible contributions.
8. True. The complex Roth IRA distribution-rules apply to the aggregate of the client’s Roth IRAs.
9. True. However, a surviving spouse can rollover to a spousal IRA, then convert to a Roth IRA.
10. False. Taxes and a penalty may apply, but the option to take the money out is always available. Required minimum distributions (RMDs) apply to beneficiaries, with a possible exception for a surviving spouse.
11. False. Unlike a contribution, a Roth IRA conversion can be made regardless of compensation income.
12. False. Remember that beneficiary designations should be made on all new IRAs.
13. True.  
14. False. Assets re-characterized can be re-converted at the latter of (1) the year after the year of conversion, or more than 30 days after re-characterization.

Multiple Choice

  1. Roth conversions involve the following consideration:

    1. The expected income-tax rate for the year of conversion compared to the tax rate(s) for the withdrawal years.
    2. The time horizon of withdrawals (possibly to the taxpayer, the surviving spouse and heirs).
    3. The time horizon for conversion(s).
    4. The optimal amount to convert.
    5. The availability of funds outside the converted account to pay taxes on the conversion.
    6. The need to take RMD.
    7. Lifetime gifting intentions.
    8. Estate plans (GST issues, charitable intentions, structure, etc.).
    9. Alternate minimum tax (AMT), estate taxes and state taxes.
    10. Personal tax attributes (such as charitable deduction carry-forward, net operating losses (NOLs), etc.).
    11. Taxation of Social Security.
    12. Investment strategy
    13. .

    14. Estimated tax payments.
    15. Tax basis of account(s) eligible for conversion.
    16. Asset-protection issues.
    17. All of the above.

The answer is P. Hopefully, this was a gimme. The point earned from it is made below.

The Point

First, a well-informed analysis of a Roth conversion is complex, but essential because generally accepted rules-of-thumb too often fail. For instance, the notion that tax-deferrals are always desirable is well-anchored, and of course erroneous. Consequently, many individuals intuitively reject the idea of willingly paying taxes up front. Where applicable, clients will need facts and figures to accept the benefits of a Roth conversion.

Second, Roth conversions exemplify the entangled complexity of tax, investment, estate, protection and financial planning. The various elements of personal finance mesh together with increased complexity and frequency. As such, the amount of knowledge required to combine these planning elements exceeds the limits of human memory. However, “it’s not what you know,” wrote Google's Marissa Mayer, “it's what you can find out.”

Resources

The AICPA’s Personal Financial Planning section has gathered and placed today’s requisite information at our fingertips through the PFP Practice Portal. Of course, specific Roth conversion resources are available to section members, including client presentations, a free book by Bob Keebler, webinars and Forefield calculators.

Resources available to all include client material (PDF), a podcast and a cheat-sheet: Bob Keebler’s Roth IRA Conversion Decision Chart (PDF).

Conclusion

The plethora of considerations involved in Roth IRA conversions expands yet again the knowledge personal finance CPAs must incorporate into their tax and advisory practices. The grades we get for handling clients’ unique situations depend on the resources we give ourselves and the ability to integrate various planning considerations with client circumstances. Fortunately for CPAs, we have the opportunity to team up with peers to make this a group assignment.

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Jean-Luc Bourdon, CPA, PFS is a wealth manager with Walpole Financial Advisors, LLC (WFA) in Goleta, CA. His opinions and comments expressed within this column are his own, and may not accurately reflect those of WFA. This information is being provided for informational purposes only and does not constitute investment or tax advice. Nothing in these materials should be interpreted as implying the performance of any client accounts, or securities recommendations. Bourdon volunteers as financial literacy advocate. He also currently serves on the UW-Platteville’s Distance Learning Alumni Advisory Board. All members of the AICPA are eligible to join the PFP section. For CPAs who want to demonstrate their expertise in this subject matter apply to become a PFS Credential holder.