Time is Running Out to Convert Your IRA . . .

Through the end of this year only, there is a special tax benefit if you convert your traditional IRA to a Roth IRA, which allows you to make tax-free distributions from your retirement account. There is no income limitation, which previously disallowed a Roth conversion if your adjusted gross income was greater than $100,000. Before 2010, if your tax filing status was married filing separately you were not able to convert either, but this restriction has been lifted as well. Additionally, one of the reasons to take advantage of this during 2010 is that you can include any income from the conversion on your 2011 and 2012 tax returns.

But even with these benefits, should you convert your IRA to a Roth and pay additional taxes currently? Possibly, but it depends upon your situation and several major factors. The good news is that you have some time during 2011 to convert or “recharacterize” your Roth back to a traditional IRA if you realize that would be beneficial to you. The deadline to do this is April 15th 2011, but if you file an extension you will have until October 15th 2011.

Do You Have the Money to Pay the Tax? Even though you can spread out the income from the conversion over two years, do you have the money to pay the additional taxes? For example, if you convert $100,000 and you are in the $25% bracket, do you have an additional $12,500 for each of those years? If not, then converting is not right for you. And you never want to use some of the IRA distribution to pay the tax because you will create a tax nightmare for yourself with possible early distribution penalties of 10%.

How Much Time Until Retirement? If you are in your sixties, a conversion will probably not make a lot of sense. The main reason for the conversion is to not pay any taxes in the future from your Roth, which means that you will need several years to recoup the taxes that you have paid up-front. Although, you may want to convert to minimize the tax impact to your heirs. Another benefit is that a Roth IRA does not require minimum distributions once you reach age 70 ½.

Which Tax Bracket Will I Be In? If you think that you will be in a lower tax bracket when you retire, then converting now does not make sense. If you think that you will either be in a higher tax bracket or that tax rates will be higher when you retire, then a Roth makes a lot of sense. Of course, this is a guess, but you need to make an educated guess based upon all of the known factors.

These are just a few of the factors to consider when converting your IRA to a Roth. Conversion strategies, such as filing an extension, the creation of multiple Roth accounts, or conversion of only a partial balance can also be implemented to help make your conversion more tax-efficient and allow the benefit of hindsight.