September 20 , 2009 - For some time, I have wanted to convert my regular IRAs to Roth IRAs, however, my income is too high. Is there any relief in sight on this issue?

Next year will be a pivotal one for retirement planning, as it will be the first year in which taxpayers will be able to convert funds in regular IRAs (as well as qualified plan funds) to Roth IRAs regardless of their income level. This new conversion option poses significant tax planning challenges and opportunities for 2009, 2010 and 2011.

For tax years beginning after 2009, the $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs is eliminated. Additionally, married taxpayers filing a separate return will be able to convert amounts in a traditional IRA into a Roth IRA (currently they are barred from doing so).

Roth IRAs have two major advantages over regular IRAs: (1) Distributions from regular IRAs are taxed as ordinary income. By contrast, Roth IRA distributions are tax-free if they are "qualified distributions," that is, if they are made after the 5-tax-year period that begins with the first tax year for which the taxpayer made a contribution to a Roth IRA, and when the account owner is 59 1/2 years of age or older, or on account of death, disability, or the purchase of a home by a qualified first-time homebuyer. (2) Regular IRAs are subject to the lifetime required minimum distribution (RMD) rules that generally require minimum annual distributions to be made commencing in the year following the year in which the IRA owner attains age 70 1/2. By contrast, Roth IRAs aren't subject to the lifetime RMD rules that apply to regular IRAs (as well as individual account qualified plans).

The consensus view is that the conversion route should be considered by taxpayers who: have a number of years to go before retirement; anticipate being taxed in a higher bracket in the future than they are now; and can pay the tax on the conversion from non-retirement-account assets.

Complicating factor for 2010 conversions. A unique income inclusion rule will apply for IRA-to-Roth-IRA conversions occurring in 2010. Unless a taxpayer elects otherwise, none of the gross income from the conversion is included in income in 2010; half of the income resulting from the conversion will be includible in gross income in 2011 and the other half in 2012.

A major wild card in making this choice is the tax-rate picture after 2010. Absent Congressional action, after 2010 the tax brackets above the 15% bracket will revert to their higher pre-2001 levels. The Administration has proposed to increase taxes only for those making $250,000, but it is difficult, at this point in time, to predict who will get hit by higher rates. What's more, there are proposals on the table to help finance healthcare reform with a surtax on higher-income taxpayers.

Taxpayers who intend to take advantage of the new conversion option next year should consider the following strategies:

• Non-high-income taxpayers who are able to make deductible IRA contributions this year should do so. They'll reduce their 2009 tax bill and, if they make the conversion to Roth IRA next year, they won't have to pay back the tax savings until 2011 and 2012.
• High income taxpayers who haven't made deductible IRA contributions in the past should consider making nondeductible IRA contributions this year. The conversion generally is taxable only to the extent of earnings on the nondeductible contributions. However, if the taxpayer previously made deductible IRA contributions, or rolled over qualified plan funds to an IRA, complex rules determine the taxable amount. That's because all IRAs are treated as one for distribution purposes. The annuity rules govern what part of the converted amount is treated as a tax-free return of nondeductible contributions and what part is treated as taxable.
• Some high-income taxpayers plan to make large conversions in 2010 but to opt out of the deferral of tax until 2011 and 2012 because they fear they will be in a higher tax bracket in those years than in 2010. These taxpayers should avoid the standard year-end-planning wisdom of accelerating deductions and deferring income but should, rather, do the reverse in an effort to avoid being pushed into the highest brackets by a large IRA-to-Roth-IRA conversion. These taxpayers should be considering ways to defer deductions to 2010, and accelerate income from next year into 2009.

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