Beginning January 1, 2010, conversions from a traditional IRA to a Roth IRA will become available to all individuals, regardless of their incomes.

Under pre-2010 law, the opportunity to convert a traditional individual retirement account (IRA) into a Roth IRA was limited to individuals whose adjusted gross income is less than $100,000. Beginning January 1, 2010, conversions from a traditional IRA to a Roth IRA will become available to all individuals, regardless of their incomes. This opportunity creates a dilemma for high income owners of traditional IRAs: do the benefits of allowing the assets of a Roth IRA to grow tax-free for a longer period of time outweigh the acceleration of income tax triggered by the conversion of a traditional IRA to a Roth IRA? The answer requires a close review of each individual’s objectives and circumstances.

Traditional IRA vs. Roth IRA

To understand the quandary that this change to the tax law presents to high income individuals, it is first necessary to compare the features of a traditional IRA and a Roth IRA. Distributions from a traditional IRA are taxed at ordinary income tax rates. In contrast, qualified distributions from a Roth IRA are not subject to any income tax because contributions to a Roth IRA are made with after-tax dollars.

The distribution requirements for a traditional IRA also differ from a Roth IRA. For a traditional IRA, the owner must begin receiving minimum required distributions (MRDs) in the year after the owner turns 70 1/2. The MRD rules, however, do not apply to Roth IRAs during the original owner’s lifetime. Therefore, if an individual does not need distributions from his or her Roth IRA, the assets in the Roth IRA can continue to grow tax-free for a longer period of time than a traditional IRA. Depending on the time horizon and investment returns, this additional growth in a Roth IRA can be substantial.


Beginning in 2010, individual owners of traditional IRAs can convert their accounts into Roth IRAs, regardless of their level of income. In addition, certain eligible rollover distributions from employer sponsored retirement plans, including 401(k) plans, can be rolled over directly into a Roth IRA. To determine whether a conversion from a 401(k) plan would be permitted, the terms of the retirement plan would need to be reviewed, as many plans prohibit such distributions prior to the employee’s separation from service.

Upon conversion from traditional to Roth, the entire value of the retirement account is subject to income tax as if the assets had been distributed to the owner. For conversions occurring in 2010, unless the account owner elects otherwise, the amount required to be included in gross income by reason of the conversion will be included ratably over two years, in 2011 and 2012. If the individual expects his or her tax rate to increase, he or she may want to elect to pay the entire tax immediately.

The conversion can be undone if the taxpayer changes his or her mind (for example, if the value of the assets declines after the conversion) by “recharacterizing” the Roth IRA as a traditional IRA. In the event of a recharacterization, the tax liability that would have been associated with the conversion is not incurred. The recharactarization can be made until the due date of the taxpayer’s federal income tax return, including extensions, for the year of the conversion. Thus, a conversion done in January 2010 is revocable until October 2011. If the IRA owner recharacterizes his or her IRA from Roth to traditional, there is a waiting period before he or she can convert again to a Roth.

Some factors to consider in evaluating the merits of a conversion include whether the individual is able to pay the income tax liability associated with the conversion with assets held outside the IRA, the individual’s current and anticipated future income tax rates, and the expected time horizon that the assets will be maintained in the Roth IRA. Where an individual expects to be in the same or a higher tax bracket in the future, it may be more advantageous to pay the income tax now at a lower income tax rate. Paying the income tax currently also provides the benefit of reducing the size of the individual’s taxable estate. Where the IRA owner expects to be in a lower tax bracket or plans to move to retire to a state with no income tax, the potential benefits of a conversion will be partly, but not necessarily wholly, diminished.

In addition, the benefits of conversion are amplified over a long period of time, such as when an individual converts a traditional IRA to a Roth IRA at a younger age or leaves the Roth IRA to his or her descendants at death so that the beneficiaries may “stretch” the IRA tax deferral over their life expectancies. However, the benefits of a Roth IRA conversion may be undermined where the assets of the IRA account are depleted to pay the income tax on the conversion or to support the consumption needs of the owner.

Because of the many variables involved, each situation must be analyzed based on the unique circumstances of the individual. The following examples, however, illustrate some general principles to consider.


Consider a 65-year-old couple with a total net worth of $15 million, $2 million of which is in a traditional IRA. They are currently in the highest income tax bracket and expect to remain in the highest tax bracket after retirement due to their investment income. They have sufficient assets outside the IRA to pay the income tax on conversion and to meet their personal spending needs for their lifetimes. They intend to transfer the IRA at death to their children, who will then “stretch” it over their life expectancies. In this case, all of the relevant factors would suggest that they should convert the traditional IRA to a Roth IRA.

Another good candidate for conversion is a 40-year-old professional with a $300,000 traditional IRA and $500,000 of other assets. Although the IRA represents a substantial portion of his net worth, he has a very long time horizon before he may need to draw on the IRA (at least 25 years). His current tax bracket is relatively low compared to his anticipated future tax bracket. Although paying the taxes on conversion with assets outside the IRA may appear undesirable to this young professional, he is a very good candidate for conversion. In his case, he may decide to hedge his bets and convert only the portion of the IRA on which he feels comfortable paying income taxes now and consider converting more of the IRA in the future (understanding that income tax rates are expected to increase in 2011).

A less compelling case would be a 60-year-old couple with a total net worth of $4 million, $2 million of which is in a traditional IRA. They are currently in the highest income tax bracket, but they do not expect to have significant income during retirement and expect to retire in Florida, where they will not be subject to state income tax. They need to pay the tax due on conversion from the IRA and anticipate spending at least a portion of the IRA to pay personal expenses during retirement. The potential for lower income tax rates in the future and the expectation of spending down a portion of the IRA assets during life would mitigate against conversion.