Changes in Roth Conversions for 2010

There are two basic types of retirement accounts—traditional IRAs and Roth IRAs. These differ from each other in how and when they are taxed. Traditional IRA contributions are made on a tax deductible and after-tax basis. Account growth in a traditional IRA is tax-deferred until withdrawal. With a Roth IRA, only after-tax funds can be contributed, and growth on and withdrawals from a Roth IRA are tax-free. In the past, individuals with traditional IRAs could convert to a Roth IRA only if they were within a specified income limit and could pay taxes on the converted money. Beginning in 2010, however, anyone can convert their traditional IRA into a Roth IRA and income taxes due from the conversion can be spread over 2011 and 2012.

Is A Roth IRA Conversion Right For You?

These new tax rules may be beneficial to you because once your traditional IRA is converted to a Roth IRA, you will never have to pay taxes on that account again. Your Roth IRA account would continue to grow tax-free indefinitely. With this new rule, high-income earners who were previously excluded from contributing to a Roth IRA can now enjoy some benefits of this tax-free account, though they still cannot fund a Roth IRA.

Here are some reasons you should consider a Roth Conversion:

Unknown Future Income-Tax Rates—Current income tax rates are considered to be low when compared to rates for the last 50 years. If your income tax rate is higher in retirement, the tax cost of withdrawals from a traditional IRA could be considerably more.
Potential for "Tax-free Stretch"—If you will not need all of the money in your IRA for your own retirement needs and plan to leave your account to your beneficiaries, converting to a Roth IRA will allow your inheritance to grow tax-free throughout the beneficiary's lifetime. The result would be a substantial increase in distributions for your beneficiary.
Managing Social Security Taxability—Roth IRA distributions are not used to calculate the taxability of Social Security benefits. A conversion could lower your Modified Adjusted Gross Income enough to halve or eliminate taxes on your SS benefits.
Lower Tax Bracket in Retirement—Roth IRAs allow you to supplement your retirement income with tax-free income. This may help some retirees stay in a lower tax bracket and save money on their taxes.

Converting to a Roth IRA is not for everyone, however. If a large amount of the contributions to your traditional IRA were made pre-tax, for example, the taxes due on the conversion could be more than you can currently afford. It's important to discuss your particular financial situation with a qualified tax and financial professional like our consultants at James T. Borello & Co. We will review your retirement plans and your financial objectives to determine if a Roth conversion will be beneficial to your situation.