Should You Convert to a Roth IRA in 2010?

A Roth IRA is a special type of an individual retirement account (IRA) that has many important differences from a traditional IRA.  Those differences may make the use of the Roth IRA superior to using a traditional IRA, depending upon your situation.  Contributions to a Roth IRA are not deductible, but qualifying distributions (including earnings) from the Roth IRA are not taxable.  Inherited Roth IRAs will also provide income tax-free distributions to your beneficiaries.  Furthermore, unlike a traditional IRA, contributions can still be made after age 70 1/2 and the lifetime minimum distribution rules do not apply.

Those having a traditional IRA may convert or change to a Roth IRA.  However, the ability to convert is denied those having AGI in excess of $100,000.  In the year 2010, this AGI limitation is removed.  A conversion is treated as a taxable distribution not subject to the 10% premature penalty tax for those under age 59 1/2.  If income tax is due on the amount converted, why should you convert?

There are many factors to consider, and your specific situation must be analyzed before proceeding with a conversion.  However, timing for the conversion may be the very best in 2010 for the following reasons:

• The value of your IRA may be temporarily depressed because of market conditions, so the tax cost on conversion will also be less.
• Income tax rates are scheduled to increase in 2011.
• Taxable income from 2010 conversions may be recognized 50% each on your 2011 and 2012 tax returns instead of 100% on your 2010 return, possibly staying in lower tax brackets by splitting the income between tax years.  Conversions after 2010 must be 100% recognized in the year of conversion.

If you decide to convert and pay the conversion tax in 2010, you should consider certain additional tax planning steps such as shifting deductions to 2010 when your tax bracket may be higher than in 2009 or 2011 because of the additional conversion taxable income.