Could converting your IRA to a Roth IRA benefit you? Maybe.

Although there are benefits to converting
your IRA, especially in light of the 2010 provisions, there are also variables and potential pitfalls you should consider.

The traditional IRA allows for contributions to the IRA by an individual taxpayer with the benefit of a deduction on the taxpayer’s individual tax return. The taxes on an IRA’s earnings are “deferred” until the individual taxpayer begins to withdraw distributions. Each future distribution would generally be taxed at the individual’s current tax rate.

Roth IRAs, established by the Taxpayer Relief Act of 1997, do not require a minimum annual distribution and the distribution’s earnings are tax free. Thus, the assets can grow without taxation for as long as the individual chooses. However, the amount of money converted to a Roth IRA must be reported as income and taxed in the year of conversion at the then individual tax rate in effect. Due to the Tax Increase
Prevention and Reconciliation Act of 2005, there are a few key changes effective January 1, 2010, that make conversions to Roth IRAs worth considering. First, if the conversion occurs in 2010, the individual can elect to delay reporting the conversion for one year and then “split” the taxable converted amount between 2011 and 2012 (50% each year). This delayed reporting and “split” election is available only for 2010 conversions. In addition, effective January 1, 2010, the original $100,000 income limitation for Roth IRA conversions was eliminated.

Although a conversion from a traditional IRA to a Roth IRA may be a good strategy for some taxpayers, there are a few questions to consider:

What should I consider before deciding on a Roth IRA conversion?
Each taxpayer should determine if he/she has the cash available to pay the taxes on the conversion, especially in today’s economic environment. In addition, the taxpayer should determine what effect individual taxes and tax rates will have on his/her financial situation now and in the future.

When is a Roth IRA conversion beneficial?
The Roth IRA conversion is beneficial when you expect to have higher average income tax rates during retirement than in the year of conversion. There can be other instances in which a Roth conversion makes sense. You should discuss possible conversions with your tax advisor in light of your individual
circumstances.

What potential pitfalls should the taxpayer avoid in a Roth IRA conversion?
One potential pitfall is the value of your Roth IRA account could suffer market declines after the conversion. Consequently, you would have paid tax on the higher value when you converted to the Roth. You can minimize this potential pitfall by strategically splitting the IRA (or a portion) into two Roth IRA’s to separate the investment risk should you need to re-characterize your Roth IRA conversion back
to a regular IRA. The ability to re-characterize your conversion expires on the due date (including extensions) of your income tax return. If you are considering converting all or a portion of your IRA to a Roth IRA, your tax advisor can assist you with the risks and rewards of your particular situation.

In summary, the Roth IRA conversion may be a good strategy for some taxpayers; however, a detailed examination and analysis of individual circumstances,calculations of “what if” scenarios and careful planning should occur before any decision to effect the Roth conversion is made. Contact your tax professional for additional information regarding Roth IRA conversions.