Money invested in a traditional IRA is tax deductible and then grows tax-deferred until it is withdrawn. Money contributed to a Roth IRA is not income tax deductible, but all earnings and withdrawals from the account are income tax-free. In some cases it is possible to convert a traditional IRA to a Roth IRA and achieve significant tax savings.
Effective January 1, 2010, the income limits that have previously prevented taxpayers with a modified adjusted gross income exceeding $100,000 per year from converting their Traditional IRAs into Roth IRAs are removed for federal income tax purposes. You will have to pay income tax on all assets converted from a traditional IRA to a Roth IRA, but you are allowed to spread the tax liability out over two years if the conversion occurs in 2010.
Wisconsin, however, is one of a small minority of states that has not aligned the state's income taxation of Roth IRA conversions with that of the federal goverment. Wisconsin residents who convert Traditional IRAs to Roth IRAs would be subject to a penalty of 3.33% on the initial withdrawal from the Traditional IRA and an additional 2% each year for having the funds in the Roth IRA. Wisconsin representatives have introduced a bill that would eliminate these penalties. However, this bill has not been passed and may never pass. Therefore, it is critical that Wisconsin residents factor in these additional penalty amounts when considering whether to convert to a Roth IRA.