There are several important things you should consider before converting IRA assets to a Roth IRA during the base income year of college or during college years.
If you have IRA contributions in mutual funds or other investments, you can convert your IRA retirement assets directly into a Roth IRA without liquidating the asset into cash first.
There is no deadline for converting an IRA to a Roth IRA. However, if you convert the IRA in the tax year 2010, you can split the taxation of the IRA between the tax years of 2011 and 2012. If you want until 2011 or later to make the conversion, you cannot split the taxation to future years.
In other words, the taxation will be due in the year of the conversion. At the present, individuals can convert an IRA to a Roth as long as your MAGI income is less than $100,000. These limits are for single as well as taxpayers filing jointly. If you are married and elect to file separately you are not eligible for the conversion, unless you have lived apart from your spouse for the entire year. GOOD NEWS! If you convert your IRA to a Roth in the tax year 2010, there is NO income limitations.
If you convert an IRA to a Roth there is a tax on the conversion of the taxable amount converted. This tax is calculated based on your marginal tax bracket.
You do not have to convert all of your retirement assets at one time. By spreading the conversion out will limit the amount of taxes you will have to pay over several years. However, remember the income limitation I mentioned earlier. When you convert your IRA to a Roth you will need to complete IRS Form 8606.
If you are in the base-income year and will be completing the FAFSA or CSS Profile or your student is already in college, you need to be careful. Since the conversion is a taxable event, the conversion could disqualify your student from receiving need-based financial aid. The reason for this is, the conversion must be reported as taxable income when you file your taxes. The more income you show on the FAFSA or CSS Profile the less financial need you could qualify for.
For some individuals that will not qualify for need-based financial aid the conversion will not make a difference. However, if the additional income from the conversion forces your income above $160,000 (filing jointly) or $80,000 (filing single) in the year your student attends college, you will reduce your opportunity to get the full benefit of the American Opportunity Tax Credit.
If you convert your IRA in the base-income year or during your student’s stay in college, some financial aid officers will not count the conversion as available income when they are considering financial aid for your student. However, this is NOT a guarantee. Some financial aid directors will consider the conversion as available income. If you do not know how the Financial Aid Officer will treat the conversion, you can call the college and ask.
Some individuals may not include the conversion on the FAFSA or CSS Profile, but I caution you not to do this. The reason for this is the college can find out about the conversion by what is call Verification. Verification is a technique colleges use to verify if the information on the financial aid application is correct. If you are call up on Verification you will have to provide a copy of your federal tax returns, thus the financial aid director will see the conversion.
Most individuals do not take into consideration of how taxes affect how they will pay for college costs. In many situations, reducing federal and state income taxes is just like getting a scholarship directly from the federal and state governments. However, before incorporating any tax strategies it is highly recommend talking to a certified college consultant and your tax professional, before making any decisions.
There are other considerations you should consider before converting your IRA to a Roth. You should talk to your financial advisor and tax professional about the timing of the conversion, taxes, and your future retirement income compared to your present income.