Starting in 2010, all taxpayers, regardless of the amount of their adjusted gross income (AIG), can convert a traditional individual retirement account (IRA) to a Roth IRA. You cannot convert prior to 2010 if your AGI exceeds $ 100,000. The $ 100,000 AGI limitation does not include any income resulting from the conversion. Amounts converted must be included in income but they are exempt from the 10% early withdrawal penalty.

The tax can be paid in two installments in 2011 and 2012, with no tax due in 2010, if you convert in 2010. However, if you prefer, you can elect to pay the tax in 2010, which may make sense if the current lower tax rates are not extended beyond 2010 or you expect significantly higher income in 2011 and 2012. Taxes on conversions made after 2010 must be paid in the year of conversion.

Even though this tax rule does not go into effect until 2010, you should start planning now. For instance, you could make the maximum IRA contributions to a nondeductible IRA in 2007, 2008, and 2009, and then convert the nondeductible IRA to a Roth IRA in 2010. The maximum IRA contribution is $ 5,000 in 2008 plus an additional $ 1,000 catch up contribution for taxpayers age 50 and older. After 2008, the contribution amount will be adjusted for inflation in $ 500 increments.

You would only have to pay income taxes on earnings within the non-deductible IRA. However, be aware that if you also have other traditional deductible IRA funds, you cannot solely convert the nondeductible IRA. You have to assume that a pro-rata portion of both the deductible and nondeductible IRA funds are being converted.

This new conversion provision effectively removes income limitations from contributions to a Roth IRA after 2010. In 2008, Roth IRA contributions can be made by single taxpayers with AGI less than $ 101,000 (contributions are phased out with AGI between $  101,000 and $ 116,000) and by married couples filing jointly with AGI less than $ 159,000 (contributions are phased out with AGI between $ 159,000 and $ 169,000). Starting in 2010, individuals with incomes over the limits can make contributions to a nondeductible traditional IRA and then immediately convert the balance to a Roth IRA.

There are a variety of factors that determine whether an IRA conversion to the ROTH IRA makes sense. Factors that favor converting include:

1. You will not use funds from the IRA to pay the taxes.
2. You expect your future marginal tax rate (or your beneficiary’s) to be equal to or greater than your current marginal tax rate.
3. You won’t make withdrawals from your Roth IRA for many years.
4. You don’t expect to need withdrawals from you IRA. Since you aren’t required to withdraw funds from a Roth IRA, even after age 70 ½, your IRA balance can continue to grow on tax-free basis.
5. You want to leave your IRA balance to Heirs. Once the balance is converted, a qualified distribution (i.e. withdrawal) cannot be taken for five years. Distributions before then are subject to the 10% early withdrawal penalty, unless one of the exceptions applies.

For questions related to Retirement Planning, please call Jeremy Kisner, CFP at 702-256-7400