Congress Agrees on Tax Relief and Eliminates Income Limitations on Roth IRA Conversions

May 12, 2006

President Bush signed the Tax Increase Prevention and Reconciliation Act of 2005 into law on Wednesday, May 17. The Act includes provisions that extend the current reduced tax rates on capital gains and dividends and increases the threshold for those obligated to pay an alternative minimum tax.

Roth IRA Conversions

The tax reconciliation bill also includes a provision that would eliminate the income limitations for Roth IRA conversions. This is significant for public sector employees that have transferred their 457 or 401(a) plan balances to a Traditional IRA. Those individuals will be able to convert their IRA balances to a Roth IRA and pay the tax. In making the conversion, they may be hedging against the likelihood that taxes will increase from the current, all-time low, tax rates to higher rates later when they are taking distributions.

If you convert your Traditional IRA to a Roth IRA in 2010, income averaging advantages will be allowed. Specifically, for conversions pursued in 2010, half of the tax liability is due in 2011 and the other half in 2012. ICMA-RC will continue to keep you informed of any developments and how we can assist you in easily converting your Traditional IRA to a Roth IRA beginning in 2009.

Background

The rationale for the Roth IRA conversion provision is three-fold; it:

• Allows individuals that would otherwise be over the $100,000 AGI limitation (for individuals and married couples filing jointly) to convert Traditional IRAs to Roth IRAs
• Assists individuals in their retirement tax and distribution planning by allowing higher income individuals to diversify their retirement savings’ balances from a tax perspective*
• Raises $6.4 billion over 10 years for the Federal government and pays for other tax cuts

You can find the Senate Finance Committee summary of the bill, and the full statutory language of the bill, at http://finance.senate.gov/sitepages/legislation.htm. For additional coverage of issues and policies that are critical to building retirement security go to our Legislative Report section.

* For example, where a traditional defined benefit, 457 or 401(a) distribution would be taxed, the Roth IRA would not be taxed on distribution because the tax would have been paid at the time of conversion.