How to Benefit from the New 2010 IRA Conversion Rules

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If you have funds in an individual retirement account, the federal government has afforded you a unique opportunity in 2010 to convert those funds to a Roth IRA. The Roth IRA can provide you with a tremendous tax-free stream of income in retirement.

Although the ability to convert an IRA to a Roth has been available since the inception of the Roth in 1998, many were restricted from doing so due to income limitations. Until 2010, a conversion was not allowed if your modified gross income was more than $100,000. The lifting of this restriction this year gives these individuals their first chance to take advantage of the benefits of a Roth.

Roth IRAs offer several key benefits over traditional IRAs, which make a conversion a smart move in many cases. Unlike the traditional IRA, which provides you with a tax deduction on your contribution, a Roth offers no upfront tax break on invested money. However, a Roth does offer tax free growth and withdrawals at retirement.

What does this mean for you? It means that by paying the tax on your invested money today, you will have the opportunity to grow your funds without any interference from Uncle Sam ever again. Roth IRAs are also not subject to the same required minimum distribution rules as traditional IRAs, so you will not be required to begin taking withdrawals upon turning 70 ½.

In addition to all the benefits that a Roth offers, the government is now allowing you to spread your tax liability over a three-year period. Once a conversion to a Roth IRA is made, you will be responsible for paying income taxes on the money that was converted. Because a Roth offers no upfront tax break, the tax is due at the time of conversion. Eue to the new rules applied in 2010, that tax liability can be spread over three years. Essentially, a portion of your 2010 tax liability can be deferred to 2011 and 2012 as well.

Paying the tax on all converted money now may sound like an expensive proposition, but given the deflated levels of the current markets and the challenging environment our economy has experienced the past few years, it creates even more favorable conditions for converting with a relatively low tax liability. Once the markets recover, all of that growth will be tax free.

It may not be the right move for everyone to take advantage of this opportunity. Those who benefit the most are either young or in a low tax bracket for the 2010 tax year. Exploring the option does make sense for just about everyone with a traditional IRA. Talk to a Certified Financial Planner to find out if it makes sense for you. If it does, you may be taking advantage of one of the best tax strategies the government currently offers.

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