Roth IRA Conversions Possible, But Not Always Beneficial

As of Jan. 1, the income cap on moving assets held in a traditional IRA into a Roth IRA disappeared. This means that although certain income-earning individuals are still barred from contributing to a Roth IRA, these individuals may now contribute to a traditional IRA and then convert to a Roth IRA.  

According to Kelly Greene, Ready to Roth: How You Fund an IRA Conversion Through the ‘Back Door’, WSJ, Jan. 16, 2010, Roth IRA conversion amounts will be subject to some, if not hefty, income taxation:

You can convert all, or part of, your traditional IRA assets to a Roth, but you owe tax proportionately on the amount that wasn’t taxed previously. 

Basically, you can’t cherry-pick the assets you convert. Instead, the IRS says you must first take the balance in your IRA, or the combined balances of multiple IRAs, and then divide any nondeductible contributions by that balance. This gives you the percentage of any conversion that is tax-free.

The benefit of converting will largely depend on whether the expected tax on withdrawals from the traditional IRA is higher than the tax on converting to a Roth IRA, in addition to other long-term estate planning considerations. 

See TIAA-CREF, Which Type of IRA Makes the Most Sense for You (this is a pdf linked to the right hand column of the linked page); see also

Ann Tergesen, Roths: Your Questions, Our Answers, WSJ, Dec. 20, 2010.