NEW YORK (2/24/10)--This could be the year to convert your traditional individual retirement accounts (IRA) into a Roth IRA. But don’t make the expensive mistake of converting without understanding how it will affect your taxes (MSN Money
Feb. 11). These common uninformed errors can lead to higher tax bills than you anticipate:
* You think that evenly split conversion income means evenly split tax. It’s true that if you convert in 2010, you won't have to include conversion income on your 2010 tax return. Instead, you can include half the income from the conversion on your 2011 return and half on your 2012 return. But don’t think that because you evenly split the conversion income, the tax will be evenly split as well. Your total tax bill depends on a number of factors, many of them outside your control. * You miss the 60-day rollover deadline. The best way to move the money is by trustee-to-trustee transfer, also called direct rollover. But if your company plan or IRA custodian doesn’t offer this kind of transfer, you’ll probably get a check from your firm, written out to you as the account owner. You have 60 days to place these funds into another qualifying retirement account, including a Roth IRA. If you miss the deadline, the funds become taxable and no longer are eligible for rollover. The fix can be costly and time-consuming, and the Internal Revenue Service (IRS) doesn’t have to accept it. * You don’t take your Medicare or Social Security benefits into consideration. If you’re receiving these benefits and complete a Roth IRA conversion, you might have to pay higher Medicare premiums or have your Social Security payments taxed. Medicare Part B premiums are based on income; if you convert a large amount of money, it could move you into a higher premium bracket. Your Social Security benefits are generally excluded from gross income and not taxed, but depending on how much other income you have, 50% to 85% of your Social Security income can be included in your gross income. That means a higher tax bill for that year.
More traps await the uninformed:
* Income from conversion could affect financial aid for your children; * Some funds are ineligible for conversion; and * Partial conversions involving after-tax money can cost more than you anticipate (same with not taking your required minimum distribution before converting).
These lists are not comprehensive. Address every tax and planning detail with a professional before you make a conversion to save yourself a financial let-down.