During 1997 I posted an entry to this site detailing the provisions of the Tax Reconciliation Act of 2005 that allows investors to convert their traditional IRA to a Roth IRA without consideration of income limitations that currently prevent investors with adjusted gross incomes in excess of $100,000 from converting. The Act also allows investors to pay the resulting tax bill over the 2011 and 2012 tax years. Effective January 1st of 2010 investors will need to evaluate whether a conversion is in their best interest.
I would love to be able to provide a simple list of criteria where an investor can decide whether they should convert. However, such a list is not possible because the answer is different for everyone. However, I can suggest several items that should be considered in your evaluation. The list generally consists of your current marginal income tax rate, your expected marginal income tax, when and if you expect to withdraw the money from the IRA, and your current age.
The tax rate consideration is relevant because you will need to pay income taxes on the amount converted based on your current marginal income tax rate at the time of conversion. If you anticipate your marginal tax rate to increase dramatically during the expected withdrawal period, it would lead you to consider converting now. Alternatively, if you expect your marginal tax rate to decrease during the expected withdrawal period, it would lead you to consider converting at a later date or possibly not at all.
If you never expect to withdraw the money, you should consider converting to a Roth. A Traditional IRA is subject to Required Minimum Distributions as required by the IRS beginning at age 70. The IRS wants their tax money at some point and if you have not taken the money by age 70, they require you to begin withdrawing the money based on your life expectancy so that they can tax you on the withdrawn amount. One of the primary advantages of a Roth IRA is that it does not have Required Minimum Distribution requirements.
Another consideration relevant to conversion is your current age. A younger person has more time to make up for the tax paid on the converted amount. Alternatively, an 80 year old person can convert to a Roth IRA and pay the tax bill but they are not as likely to live long enough to allow for the tax-free growth to make up for the income taxes paid.A final consideration is whether the investor has enough money outside the IRA to pay the income tax liability related to the conversion. If cash is not available outside the IRA to pay the tax, it is not likely for conversion to be beneficial because using IRA money to pay the tax mathematically offsets the benefit of the conversion.
These are just a few of the factors that should be considered in evaluating the benefits of a conversion to a Roth IRA. You should consult with a financial advisor to discuss your unique situation.