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2010: A Roth Conversion Odyssey

Jessica Lanning

Starting in 2010, the tax rules change such that anyone, regardless of income level, can convert his or her Traditional IRA into a Roth IRA.  Compared to their Traditional cousins, Roth IRAs have the distinct advantages of (1) tax-free growth; (2) tax-free access; and (3) no required minimum distributions at age 70 and a half.  Owners of Traditional IRAs should seriously consider a conversion. 

To Roth or Not To Roth

There’s much to consider in deciding whether to convert an IRA:

  • Do you think you’ll be in a higher tax bracket in retirement?
  • Can you pay the taxes owed as a result of the conversion out-of-pocket?
  • If not, will you suffer a 10% penalty for paying the taxes by withdrawing the money from the Traditional IRA?
  • Should you pay those taxes in 2010 or spread them out over tax years 2011 and 2012?
  • And more….

Do:  Talk to your accountant and financial advisor.  Find your IRA statements and your 401(k) statements from previous employers.  You’ll want to make this conversion early in 2010 (as close to January 4th as possible), so that you have lots of time to see that account perform.  If it doesn’t produce positive returns, you might want to “recharacterize” it back to a Traditional IRA.

Don’t:  Forget that there’s a tax liability incurred by making the conversion. Talk to your financial professionals about how you’ll handle that liability.  Keep in mind that 2011 and 2012 might bring higher tax rates, making an election to pay that liability in 2010 preferable.

And remember:  The removal of the income limit for conversions is permanent.  You don’t have to make a decision this year.  But the opportunity to spread the tax liability over two years is temporary.  You should also note that the income limitations on contributing to a Roth remain.

This might be a great opportunity for you.  Or maybe there’s a better way to spend that tax money.