How long do you have?
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Question: I am 62 years old. If I want to convert my traditional IRA to a Roth IRA in 2010, how long can I wait to do the conversion? When do I have to elect whether to include the income in 2010 versus in 2011-2012? When do I have to pay taxes on the conversion, assuming I elect to include the income in 2010? How long do I have to change my mind and "recharacterize" the conversion? Must I or should I get an extension of time to file my 2010 tax return to extend my options as long as possible? If I recharacterize the conversion, when can I convert the money to a Roth IRA again?
Natalie: To convert to a Roth IRA in 2010, you first must have a distribution, in calendar 2010, from a traditional IRA or other traditional retirement plan. That distribution is then deposited in a Roth IRA to complete the "conversion." Normally the distribution from the traditional plan and the deposit into a Roth IRA occur simultaneously (e.g., money is transferred directly from your traditional IRA to a Roth IRA), but theoretically you could have a distribution that occurs as late as Dec. 31, 2010, that is deposited into a Roth IRA within 60 days (that is, in early 2011), and that would still be a "2010 conversion."
I strongly advise converting at least a small amount from your traditional to a Roth IRA right now, just to get an account open; that will make it easier for you if you decide later in the year to convert more. As of now, an income tax rate hike is scheduled to occur for wealthy individuals in 2011, when the "Bush tax cuts" expire. Unless Congress acts to reverse those tax increases, there could be a 2010 year-end rush of Roth conversions as this prospect becomes more "real" to people.
The 5-year holding period required to achieve tax-free earnings in the Roth IRA begins January 1 of the year you first own any Roth IRA. So if 2010 is the first year you have a Roth IRA, your 5-year period starts Jan. 1, 2010 (even if your Roth conversion didn't happen until Dec. 2010). Of course, if you recharacterize your entire contribution (effectively wiping out your Roth IRA), the now-nonexistent Roth IRA cannot be used to start your 5-year period for a later conversion.
As to when the taxes are due on this conversion, that is complicated. The income resulting from a 2010 conversion is automatically pushed forward into the next two years, with half of the gross income being included in your 2011 income and half in your 2012 income, unless you elect OUT of that treatment. Since this election is made on your 2010 tax return, it makes sense to get an extension of your 2010 income tax return to as late a date as possible (normally Oct. 15, 2011), so you have as long as possible to decide when to include the income. Either way, your election is irrevocable and it applies to ALL your 2010 Roth conversions (though a husband and wife could make different elections, if both did 2010 Roth conversions).
Assuming you elect to have the income taxed in 2010, the tax on that income is due, at the latest, April 15, 2011. Extending the time to file the tax return does not extend the time to pay the tax. So even if (by April 15) you haven't decided whether you want to recharacterize your conversion, and you haven't decided whether (if you "keep" the Roth IRA) you want to include the income in 2010 or in 2011-2012, you should pay the full tax on the conversion no later than April 15, 2010, to avoid potential penalties: The penalty for late payment of tax would apply if you converted in 2010, elected not to push the income forward into 2011-2012, did not recharacterize your 2010 conversion, and failed to pay the resulting income tax by April 15, 2011.
There is also an obligation to pay estimated income taxes on 2010 income, so the tax due date is actually earlier than April 15, 2011. Technically, the income tax on 2010 income is due in the form of quarterly estimated income tax instalments prior to April 15, 2011. However, you may qualify for an exception to the obligation to pay estimated tax on the 2010 conversion. Exceptions would include someone who pays estimated tax equal to 100 percent (110% for high-income taxpayers) of his prior year's tax. Also, if you have salary income, you may be able to use income tax withholding from your salary to reduce or eliminate the penalty for underpayment of estimated tax. Anyone doing a substantial Roth IRA conversion in 2010 should work closely with their tax preparer to make sure they don't incur penalties for underpayment of estimated taxes.
The deadline for recharacterizing a 2010 Roth IRA conversion would be Oct. 15, 2011, for someone who files his 2010 tax return "on time." "On time" means no later than April 15, 2011, or (in the case of someone who obtains an extension of time to file the return) the extended due date. If you file your return on time, your recharacterization deadline is Oct. 15, 2011, even if you did not get an extension of time to file the 2010 return. However, it is recommended that you do get an extension of time to file the return, because if you file based on the assumption you will not recharacterize, then you later DO recharacterize, you will have to file an amended return (which is a pain).
Finally, if you do elect to recharacterize (undo) all or part of your 2010 Roth IRA conversion, you cannot convert "that amount" to a Roth IRA again until the later of 30 days after the recharacterization or January 1, 2011. But you can convert a different "amount" (such as a different traditional IRA) immediately.
Hope this is complicated enough for you!
Resources: For more on the mechanics and tax treatment of Roth IRA conversions, see the author's Special Report, Roth-Ready for 2010-and Beyond! downloadable at www.ataxplan.com ($49.95).
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