Below is an email that went out to clients yesterday.  Good explanation of who should consider converting from a tradition to a Roth IRA.  The article was written by Forrest Robertson!

Since its creation in 1998, the Roth IRA has been a favored vehicle used by investors to save for retirement.  The Roth promises tax-free withdrawals in the future with after-tax contributions today.  Up until 2010, the advantages of contributing or converting to a Roth IRA were limited to folks earning below predetermined income thresholds.  For example, in order to be eligible to convert to a Roth IRA, an individual (or couple filing jointly) had to be earning less than $100,000 in adjusted gross income in the year of conversion.  In 2010, the rules have changed.

First, a word on Roth conversions.  A “conversion” is an action whereby a current traditional or rollover IRA holder takes monies or investments from the existing IRA and deposits them into a separate Roth IRA.  In the year of conversion, the IRA holder is responsible for paying ordinary income taxes on the amount or fair market value of the total conversion.  But after certain requirements are met, the Roth IRA holder will be allowed to take distributions that are completely tax free.

For conversions taking place in 2010, new rules apply.  A summary of the rules are:

• Anyone can convert to a Roth IRA.  The adjusted gross income thresholds mentioned earlier are no longer applicable.  There are still income limitations on folks making new contributions to Roth IRAs; but conversions are OK.  The removal of income limitations for conversions is now permanent.
• The tax liability created by the conversion have the option of splitting the tax payments over 2 years, 2011 and 2012.  This benefits the investor by keeping more money in the pocket and deferring a cash outflow.  This special rule is only available to those who convert in 2010.  Starting next year, full tax liabilities will be assessed in the year of conversion.

This begs the question:  Who should convert to a Roth IRA?

Although the answer to that question can vary from person to person, there are certain conditions that can make that determination easier.  They are:

• The IRA holder should have outside funds available to pay the tax liability when it is due.  Taxes cannot be withheld on a Roth conversion.
• Younger investors could benefit more from a conversion due to the investment time horizon being longer and making up for the upfront tax outlay.
• Investors who believe they will be in moderate to high income tax brackets could benefit due to tax free withdrawals.
• Investors who have seen declines in the value or their respective IRAs have the opportunity to convert at lower amounts, with the lower taxes on those amounts and the anticipation of a market rebound.

It is a good idea to have a discussion about the appropriateness of completing a Roth conversion with your tax or financial advisor.  There is a strong likelihood of higher tax rates in the future, and thus, converting to a Roth IRA now may be something to consider.

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