A Surge of Year-End Roth IRA Conversions

Financial companies report a rush of last-minute 2010 Roth IRA conversions.

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Large numbers of retirement savers converted their traditional IRAs to Roth IRAs just in time for the year-end tax deadline. Fidelity Investments reports that 220,000 Roth IRA conversions were completed at the firm in 2010, more than a fourfold increase over 2009. And nearly a third of those conversions were executed in December 2010.

[See 10 Reasons to Open a Roth IRA.]

Bank of America executed more than 56,000 Roth IRA conversions containing $3.8 billion last year, up from 12,000 conversions in 2009. Over a quarter of the transfers (14,500) worth $1.4 billion were executed in December 2010 alone. The average Bank of America Roth IRA conversion amount was $68,000, up from $22,000 in 2009. Last-minute converters in December shifted even more into a Roth IRA, averaging $94,000.

A Roth IRA allows retirement savers to pay income tax on deposits up front, and withdrawals after age 59½ from accounts at least five years old are tax-free. In contrast, traditional IRAs give you a tax break in the year you make the deposit, but income taxes are due upon withdrawal. Traditional IRAs also require account owners to take distributions from their accounts and pay the resulting income tax each year after age 70½ or face a stiff tax penalty. Roth owners are not required to take distributions and can even pass on the tax-free money to heirs.

[See Who Should Convert an IRA to a Roth IRA.]

For the first time in 2010, the IRS allowed people making over $100,000 to convert traditional IRAs to Roths. There was also an additional one-time tax perk for retirement savers who initiated the conversion in 2010. Instead of paying income tax on the entire converted amount on their 2010 return, converters has the option to split the taxable income and report half on their 2011 return and half when they file in tax year 2012. Investors who make the conversion in 2011 will have to pay income tax on the entire converted amount on their 2011 tax return.

It was primarily people close to retirement who shifted their money into a Roth last year. Most of the households that completed a Roth IRA conversion were age 50 or older (58 percent), Fidelity found. And most of the conversions were completed online (62 percent). The majority of the December conversions occurred shortly after it was announced that tax rates would not increase in 2011, Bank of America found.

Roth 401(k) conversions have been slower to catch on. The Small Business Jobs Act of 2010 created the in-plan conversion option in September 2010, but most employers have not yet updated their retirement plans. While 50 percent of large employers with at least 25,000 401(k) participants offer a Roth 401(k) option, only 7 percent currently offer the ability to convent assets from traditional to Roth accounts within the plan, Fidelity found. A Mercer survey of 287 401(k) plan sponsors found that 38 percent plan to add a Roth 401(k) conversion option to their plan in 2011 or later years, but 45 have no plans to add the feature.

[See 5 Retirement Tax Deadlines to Plan For.]

While it’s too late to initiate a Roth IRA conversion for 2010, there’s still time to undo a 2010 conversion. Retirement savers who have changed their minds about a 2010 conversion have until Oct. 17, 2011, to shift their assets back to a traditional IRA and file an amended return.

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