Ask Carrie by Carrie Schwab-Pomerantz

Dear Carrie: With the 2010 changes in legislation regarding Roth conversions, I'm wondering if it makes sense for me. Who should take advantage of this? — A Reader

Dear Reader: Ever since Roth IRAs were introduced in the late '90s, they've been touted as a great way to save today and not pay taxes in the future. The catch was always the income cap that determined whether or not you're eligible to open one. But the new Roth IRA conversion rules that take effect this year open the door to people in higher income brackets who were previously ineligible for a Roth.

On the surface, it sounds pretty good. You can convert a traditional IRA to a Roth no matter how much money you make. Earnings grow tax-free, and withdrawals after age 59 1/2 are tax-free once you've held the Roth for five years. Why not?

The biggest deterrent is this: You have to pay income taxes upfront for the amount you convert. And that could be a sizeable tax bill. So, first you have to ask yourself if you can afford it.

Then consider this bit of conventional wisdom: "Never pay a tax today that you can pay tomorrow." A Roth conversion goes directly against this, so you're smart to carefully weigh the pluses and minuses. It may be an opportunity for some — and not a good idea for others. Like so many financial decisions, it depends on your individual circumstances. But here are a few key considerations to help determine if a Roth conversion is right for you:

— Your tax bracket: If you expect to be in the same or a higher tax bracket come retirement, by converting to a Roth, it's possible you'd pay less in taxes now than you would on future withdrawals from your traditional IRA. On the other hand, if you expect to be in a lower tax bracket when you start making withdrawals, you're probably better off sticking with your traditional IRA.

— Your time horizon: The further you are from retirement, the greater the potential benefit of converting because your money has more time to grow — and you won't pay taxes on those earnings. Your future tax savings might compensate for the current taxes you'll pay to convert.

— Estate planning: If you don't need your IRA assets yourself but plan to leave them to your heirs, converting to a Roth can be a great move. In effect, you're paying the income taxes upfront on their behalf without it being a taxable gift. And your heirs can make income-tax-free withdrawals during their lifetimes.

Also, the tax you pay on conversion reduces your gross estate, especially when you pay from assets other than your IRA.

Another timely consideration is the current value of your traditional IRA. As a result of the recent downturn, your IRA assets may be lower, which would mean your tax bill on conversion would be lower. That could be considered a bit of a silver lining — as long as you don't have to draw from your IRA to pay the taxes.

A FEW MORE PLUSES

There are a couple of other things that may help make your decision clearer.

First, you could choose to convert just a portion of your traditional IRA. That way you're spreading out your tax burden, paying taxes on the assets you convert now and delaying taxes on the remainder until later. It's kind of like diversifying your taxes.

Second, you can spread out the reportable income from your 2010 IRA conversion over your 2011 and 2012 tax bills. This could make your tax hit a bit easier to pay. But it's a benefit only if tax rates don't go up — and that's a big question right now, especially for top earners. Remember, assets you convert are included in your total income for the year, so you want to make sure the additional assets don't bump you into a higher tax bracket.

Lastly, there's no required minimum distribution from a Roth. If you want to keep your assets growing for a longer time, you can.

A BIG CAVEAT

Just because you can convert doesn't necessarily mean you should (END ITAL. If you're young and likely to have your highest earning years ahead of you, you're more likely to benefit from a Roth conversion than someone at the peak. If you're already in a high tax bracket, the benefits may not outweigh the taxes you'd have to pay on converting — or the opportunity you lose to put that money to work somewhere else.

On the other hand, no matter what your age or tax bracket, not having to worry about future income tax liabilities could be worth the cost. But beware, there's no guarantee that tax laws won't change in years to come!

This is ultimately a tax planning decision that impacts both your present and future finances. The best thing to do is consult your accountant or financial adviser and let the numbers help you decide.

Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER (tm) is president of the Charles Schwab Foundation and author of "It Pays to Talk." You can e-mail Carrie at askcarrie@schwab.com. This column is no substitute for an individualized recommendation, tax or personalized investment advice. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

COPYRIGHT 2010 CHARLES SCHWAB & CO. INC. MEMBER SIPC

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