Tax Benefits and Allocation Issues in Rollovers to Roth IRAs


For taxable years beginning before January 1, 2010, those individuals who stood to benefit most from a 401(k) plan to a Roth IRA rollover - individuals with a modified adjusted gross income exceeding $100,000 - were precluded from making a qualified rollover contribution to a Roth IRA. Starting in 2010, this cap on income was eliminated, thus making qualified rollover contributions available to higher-income participants in 401(k) and other employer defined contribution plans (assuming such participants were otherwise eligible to take a distribution).

Both Republican and Democratic senators are pushing to simplify the Internal Revenue Code by eliminating many of the special-purpose deductions while simultaneously lowering the overall tax rate across brackets. Despite this bipartisan sentiment, in 2010, the sunset of the lower tax brackets was extended to only December 31, 2012 - meaning the tax cuts that were enacted under President Bush are set to expire in the lame duck session following the 2012 presidential election. At this time, it's unclear whether the lower tax brackets will again be extended or will be allowed to expire. This situation has resulted in investor uncertainty regarding future income tax rates over the long term. As a result, there has been a new interest in rolling over retirement funds into Roth IRAs as a means to lock in lower tax rates, and tax professionals are finding a growing market for advice on the tax consequences of a rollover into a Roth IRA.

The goal of this analysis is to provide practitioners with an overview of the potential retirement and estate planning benefits of rollovers from a 401(k) plan into a Roth IRA, as well as to alert practitioners to the impact that common 401(k) plan distribution rules will have on the tax benefits of such a rollover in light of the current IRS allocation rules.

Excerpted from Texas Tax Lawyer, State Bar of Texas Tax Section, Fall 2011, Vol. 39, No. 1. To read the full article, click here.

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