By now, most financial advisors should know about the ability to convert tax-deferred traditional IRA accounts to tax-free Roth IRAs, which became law in the tax reform enacted in 1997. In the tax reform legislated in 2006, the conversion opportunity was extended to high-income earners earning more than $100,000 a year, but does not take effect until 2010.
This opportunity comes as welcome long-term tax planning for some high-income Americans. Discussions should begin now with clients so those who can benefit may start taking steps to take full advantage of this opportunity.
Before going down this road, however, advisors and clients must identify all IRA arrangements. The most important and misunderstood part of the law is the pro rata tax due on the aggregate IRA accounts. If one IRA account contains after-tax money and other accounts have pre-tax money, the accounts are aggregated in computing the tax. So, if a client has made non-deductible IRA contributions and they also have an IRA rollover from a 401(k), they will have to aggregate the accounts. The non-deductible IRA cannot be treated separately. Knowing this, the client may choose to move the rollover IRA back to a 401(k) if eligible.
