In past years, the Internal Revenue Service has imposed income limits on an individual’s ability to convert a traditional IRA to a Roth IRA. Beginning in 2010, the income limitations for a conversion have been eliminated. No matter how high your income is going to be in 2010, you will still be eligible to convert your traditional tax-deferred IRA to a Roth IRA.

Typically, the amount you convert is taxable income in the year in which you convert to a Roth IRA, and any future earnings would be tax-free if the account is held for at least five years. However, in 2010 only, taxpayers who convert can choose to defer the resulting taxable income to their 2011 and 2012 tax returns in a 50/50 split.

When converting to a Roth IRA, you should consider how long you intend to keep the funds in the IRA after conversion. The longer you will leave the funds in that Individual Retirement Account, the more advantageous it becomes to make the conversion. Also, if you feel that your tax bracket may be higher in the future, it makes even more sense to convert at current rates.

It is not mandatory to convert your entire traditional IRA balance. For high-income, high-tax-bracket investors, partial Roth IRA conversions may be especially attractive. For example, converting an entire $500,000 IRA in 2010 can generate approximately $200,000 in taxes. Even splitting the bill up by paying $100,000 in 2011 and $100,000 in 2012, you are still faced with a hefty tax bill. Therefore, a partial conversion may make the most sense.

From an estate planning standpoint, especially concerning the distribution of Individual Retirement Accounts to your beneficiaries, it is more beneficial to have a Roth IRA than a traditional IRA. Simply put, the traditional IRA distributions will be taxable to your beneficiaries, while no taxable income is recognized when distributions are taken from a Roth IRA. When reviewing your Roth conversion options, you should also take the opportunity to review your beneficiary designations to ensure that they are still appropriate.

In short, most everyone who owns a traditional, tax-deferred IRA, a non-deductible IRA, a SIMPLE IRA or a SEP IRA should at least consider their options since the favorable tax treatment has a finite life. iBi