A Roth Opportunity

Good news for individuals who’d like to convert a traditional IRA to a Roth IRA but haven’t been able to do so because of the tax law’s $100,000 income cap. Beginning in 2010, the cap is eliminated. Also, married taxpayers filing separately will be able to convert their traditional IRAs to Roth IRAs. Currently, they are not allowed to. As a result, more high earners will have the opportunity to take advantage of a Roth IRA.

Why Convert?

With a traditional IRA, income taxes are generally due on both deductible contributions and all investment earnings when they are withdrawn from the account. Also, once you reach age 70½, you must begin taking annual minimum distributions from traditional IRAs.

With a Roth IRA, all contributions are nondeductible and, thus, not subject to income tax when withdrawn (since they’ve already been taxed). Once you’ve held a Roth IRA for five years and you’re over the age of 59½ (and in certain other circumstances), you can withdraw earnings tax free. And you don’t have to withdraw money from a Roth IRA unless you want to, since there are no mandatory minimum distribution requirements.

There’s a tradeoff, though, when you convert a traditional IRA to a Roth IRA. You’ll incur a federal income-tax liability on the taxable portion of the traditional IRA in the year that it’s converted.

For a Limited Time Only

But, if you convert your traditional IRA to a Roth IRA in 2010, you won’t have to pay taxes on the conversion immediately. Unless you elect otherwise, half of the taxable amount of your IRA will be included in your 2011 income and the remainder in your 2012 income.

This tax break may not benefit everyone. After 2010, unless Congress acts, the tax brackets above the 15% bracket are scheduled to revert to their higher pre-2001 rates. Instead of the current 25%, 28%, 33%, and 35% brackets, the top four brackets will be 28%, 31%, 36%, and 39.6%. Consequently, you may pay less in tax if you elect to pay it in 2010.