Taxpayers receiving a qualified retirement-plan payout after their retirement, termination or job change face a big question: Should they postpone paying taxes by arranging for a tax-free rollover of their retirement-plan balance into a traditional IRA, or should they bite the bullet and pay taxes now before rates go up?

In most cases, there s no clear answer, unless you can predict the future. For the rest of us, here s my take.

If You Need Money Right Now

For those who need most or all of their retirement-plan payout immediately, it's important to understand the tax consequences for the amount you don't roll over.

First, you must report the taxable portion of the amount that you don t roll over as income on Form 1040. If you live in a state with a personal income tax, you ll have to report the taxable portion on their state return, too. If you ve never made any after-tax contributions to your retirement plan (most people have not), the taxable portion will be 100%. Even if you have made some after-tax contributions, the taxable portion still probably will be close to 100%.

If the taxable portion is a pretty big number (say several tens of thousands or more), the income tax hit will be a pretty big number, too. Conversely, if the taxable portion is a modest amount, the income tax hit will be modest especially if your tax bracket is lower than normal because your overall income is lower than normal, perhaps as a result of the lousy economy.

Next, you must consider whether the taxable portion of the amount that you don t roll over will be hit with the 10% premature withdrawal penalty tax. The penalty tax doesn t apply if you receive the retirement plan payout after completely terminating employment for whatever reason at age 55 or older, or age 50 or older for certain public service employees. If you re under the magic age, the 10% penalty tax will bite, unless you re eligible for an exception. The most likely exceptions are for individuals who are disabled and those who have medical expenses in excess of 7.5% of adjusted gross income.

Bottom Line: If you need the money, you need the money. Just don't underestimate the income tax cost, and don't overlook the 10% penalty tax. For more information on the penalty tax, see tax on early distributions in IRS Publication 17 (Your Income Tax) at www.irs.gov.

If You Don t Want to Pay Any Taxes Right Now

In this case, the decision is simple. You will need to roll over the retirement-plan payout into a traditional IRA. This tax-free move allows you to postpone income taxes until you start taking IRA payouts, which presumably won t be necessary until later.

Until recently, the traditional IRA rollover strategy was almost universally endorsed, because it was almost universally assumed that income tax rates during retirement would be significantly lower than the rates charged now. However, that assumption has become an increasingly dicey proposition.

Still, you may choose the traditional IRA rollover option perhaps because you re adamantly opposed to paying taxes any sooner than necessary or for other tax-smart reasons. That s fair enough, but you should make sure to avoid the common rollover pitfalls.

If You Would Consider Paying Taxes Now to Avoid Higher Taxes Later

If you believe you ll be paying the same tax rates or higher in your retirement years, you might want to forgo the time-honored traditional IRA rollover strategy and instead roll your retirement-plan payout into a Roth IRA. Starting in 2010, this option is available to everyone regardless of income. The Roth IRA rollover move will trigger a current income tax hit on the taxable portion of the amount rolled over, but today s tax rates are probably the lowest you will see for the rest your life.

Once the money is safely in the Roth account, any subsequent earnings and gains will accumulate tax-free and can eventually be withdrawn tax-free during your retirement (or by your heirs, if the account is left to them).

If tax rates go way up (a distinct possibility), the Roth strategy will look smart because you will have effectively prepaid your tax bill at today s lower rates. That said, the only certainty is that the Roth strategy will trigger an immediate income tax hit that could have been deferred by taking the easy way out and rolling the money into a traditional IRA.

The Roth strategy can be implemented in two different ways. You can roll the money into a traditional IRA tax-free, and then convert that account into a Roth IRA and pay the resulting tax hit. Alternatively, you can roll the money directly into a Roth IRA, which is a taxable transaction that will trigger the same tax hit. Either way, we are talking about a Roth conversion maneuver here. Please read my January column for more on Roth conversions, including some favorable considerations that are new for this year.