Now everyone can have a Roth IRA, regardless of income. Four years ago, back in 2006, President Bush signed a $70 billion tax cut provision that changed the eligibility rules for Roth IRA conversions for 2010 and beyond. Starting this year, taxpayers with modified adjusted gross income (MAGI) of more than $100,000 will be allowed to convert a traditional IRA to a Roth IRA. This change applies to all years beyond 2010 too. To help lessen the bite from the tax bill, taxpayers have the option to pay all of the taxes in 2010 or they will be spread out over two years (2011-2012). Conversions in the years after 2010 are included in income during the tax year in which the conversion is completed. There is no option after 2010 to pay the tax over multiple years.

This new law removes the Roth IRA conversion cap but doesn't remove the cap for contributing to a Roth IRA. But a taxpayer can make their 2010 IRA contribution to a Traditional IRA and then convert it to a Roth. So the way the law is currently written there is a loophole that allows every taxpayer to fund a Roth.

The old adage “just because you can, doesn’t mean you should” applies to Roth conversions. We love the benefits of the Roth IRA, but converting a Traditional IRA or qualified plan (i.e. 401(k), 403(b)) to a Roth IRA does have a downside — Taxes!

Assuming you deducted your contributions to your Traditional IRA or your employer plan, the entire amount you convert will be taxed at your highest marginal tax rate. So the amount you convert puts you into a higher income bracket, you will pay tax at that rate on the conversion amount. And for the conversion to make sense in the long run, the taxes should be paid for from a source outside of the IRA, because any money taken out of the IRA to pay taxes would be considered a distribution and subject to taxes and possibly a penalty. The longer the amount of time you expect to keep the money growing tax-free in the Roth, the more a conversion may make sense.

When this law was enacted, Congress removed the income limitation on these conversions because it allowed them to bring the tax law into compliance with budget limitations. The idea was that more people would convert to Roth IRAs and therefore pay more taxes in the short run. (They didn't care about the long run because the budget rules don't look that far ahead.) There's a possibility that Congress will take a second look at this law and decide this change isn't a good idea.

Remember that whether you choose to convert some or all of you IRAs and/or employer plans to Roth IRAs get advice from someone you can trust. The banks, brokers and mutual fund companies talking about converting to Roth IRAs, are looking to be the custodian/trustee of your IRA money. They make money from having your money so their advice is not always in your best interest.

Questions? Call the Financial Hotline 1-800-654-6023