5 Reasons to Convert to a Roth IRA

After waiting nearly four years, a new group of American workers is about to have access to the Roth Individual Retirement Account (IRA).

Beginning in January 2010, most individuals who have a modified adjusted gross income (MAGI) of more than $100,000 will be able to convert a portion of their retirement savings from their traditional IRA or 401(k) into a Roth IRA. The change was signed into law by President Bush in May 2006 as part of a $70 billion tax cut.

With a Roth IRA, participants are taxed on their contributions, but they can make tax-free withdrawals once they hit age 59 1/2 (although they must have held the account for at least five years). Before the new regulation, the plan worked best when the person contributing to the account was in a lower tax bracket than they expected to be in the future, when they started withdrawing money for their retirement. That way, they wouldn't have to pay much in taxes upfront, says Pamela Hess, the director of retirement research at Hewitt Associates, a human resources services company.

But now, the Roth IRA could be appealing for a wider variety of savers. Higher-earning individuals will soon be able to convert to a Roth IRA. People who find themselves unemployed or making less – and are suddenly in a lower tax bracket – should also consider rolling over existing retirement accounts into a Roth IRA.

Legislation in Congress could change the landscape of IRAs, as well, making them the default retirement savings option for many Americans. President Obama’s financial regulatory reform legislation includes a proposal that would require employers to set up automatic-enrollment IRAs, retirement accounts that allow for tax-deductible contributions. If the measure passes, companies that don't offer a tax-deferred retirement-savings plan would make employee contributions into IRA accounts through direct payroll deposits.

Here are five reasons to consider converting to a Roth IRA soon:

High-income earners will have a momentary shot at taking advantage of the Roth IRA's perks. In 2010, most people will be able to convert a portion of their traditional IRA or 401(k) into a Roth IRA, regardless of their income.

Now, conversions are only an option if your MAGI – not including additional taxable income triggered by the conversion itself – is $100,000 or less. Married individuals who file their taxes separately are ineligible regardless of their income. (To contribute, as opposed to convert, to a Roth IRA, single filers need a MAGI of below $120,000, and those who are married filing jointly need an MAGI below $176,000. The maximum contribution is $5,000 a year – or $6,000 for those who are at least 50 by year-end.)

Another new perk coming next year: deferred taxes. Those who convert to a Roth IRA in 2010 can spread their tax liability out across 2011 and 2012, thereby reducing some of the immediate tax hit, says Petra Campos, a retirement director for Charles Schwab. They’ll pay half the income they convert in 2011 and the other half in 2012 at whatever tax bracket they’re in during those years, says Sheryl Garrett, a fee-only certified financial planner.