Roth IRAs have several advantages over a traditional IRA: you are not required to take minimum distributions at any time; when you take qualified distributions, you don’t pay tax on the earnings; and if you need emergency funds before retirement, you can withdraw your contributions (but not earnings) without penalty. 

The benefits are so substantial that for most taxpayers they outweigh the cost of converting a traditional IRA to a Roth.  (Because traditional IRA contributions are made with pre-tax dollars, taxpayers converting their accounts must report the amount of those contributions as income in the year of the conversion and pay tax on the additional income.) 

That option hasn’t been available to taxpayers with an adjusted gross income over $100,000.  In fact, direct contributions to Roth IRAs are not available at all to taxpayers over specified income levels (depending on filing status).

But starting in 2010, high-income individuals will be able to convert a traditional IRA to a Roth. For accounts converted in 2010 only, the amount of the untaxed contributions can be reported as income over the next two years.  For accounts converted after 2010, the untaxed contributions must be reported as income in the year the conversion occurs. 

The expansion of Roth IRA conversions to higher-income taxpayers effectively means that these individuals can avoid the income limit on contributing to a Roth IRA.  Instead, you can make contributions to a traditional IRA account, and then immediately convert it to a Roth. 

In some circumstances the conversion may be tax-free.  However, if you hold a mixture of taxable and non-taxable traditional IRA accounts the conversion may result in a higher-than-expected tax bill. 

Even when the new rules go into effect, determining the most tax-advantageous way to contribute to your IRA will remain a complex endeavor.  Contact us, and we can help you analyze your situation and recommend the best course of action.