How converting to a Roth IRA works

Converting to a Roth IRA involves moving assets from your traditional IRA or employer-based retirement plan to a Roth IRA. While you'll pay taxes now on the pre-tax assets you convert, your money will grow tax-free in the Roth IRA — and withdrawals will be tax-free as well, when you have met certain requirements.

Benefits Reasons to consider converting to a Roth IRA	Considerations Conversions make the most sense if you meet the following guidelines
You can access your conversion assets (excluding earnings) after five years without penalty for any reason. You can use money in your Roth IRA tax-free for a first-time home purchase ($10,000 lifetime limit). Assets that have a depressed value, as in a down market, will not create as large of a tax bill.	You have enough money outside your retirement accounts to pay the conversion-related taxes. You have a long time frame (five years or more) before you need the money. You are in a lower tax bracket now than you (or your beneficiaries) will be when the money is accessed.

Roth conversions are currently only available to taxpayers who have a modified adjusted gross income (MAGI) of $100,000 or less. However, the income limit is eliminated for conversions made in 2010 or later. You do not need earned income to convert to a Roth IRA.

Tax-free Roth distributions

Qualified distributions from a Roth IRA are free from income tax. For a distribution of earnings to be considered qualified, it must:

1. Take place at least five years after the first day of the year you first made a Roth IRA contribution or converted to a Roth IRA

2. Also meet one of the following conditions:

• Made on or after the date that the Roth IRA owner reaches age 59 1/2
• Made due to disability
• Made to a beneficiary after the owner's death
• Meets the requirements for a first home purchase (up to a lifetime limit of $10,000)

Distributions of conversion assets (excluding earnings) can be made tax- and penalty-free for any reason five years from the first day of the year you converted.²

New conversion rules in 2010

The Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005 permanently repealed the $100,000 MAGI limit for Roth conversions. The law, which becomes effective in 2010, also permits conversions by taxpayers who are married but filing separately.

For conversions that occur in 2010 only, there is a specific tax opportunity — any income claimed on the conversion can be reported equally over two years, 2011 and 2012.

In the meantime, here are ways you can help maximize the amount you will be able to convert in 2010 and beyond:

• Make the maximum annual contribution to a traditional IRA, which you can later convert to a Roth.
• If you are not eligible to contribute to a deductible IRA or Roth IRA, consider making non-deductible IRA contributions. These will not be subject to tax in a Roth conversion, but be careful — the rules for calculating the taxes due on a conversion when you have pre-tax and after-tax money in your IRA are complex.
• Consider maximizing your contributions to your employer plan. When you are eligible to take a distribution, these contributions can be directly rolled over to a Roth IRA.

The advantage of Roth conversions during market declines

Completing a Roth conversion during a market decline can save you money on the taxes due upon conversion. You'll pay taxes on the current value of the assets being converted, and then enjoy tax-free growth and tax-free withdrawal of the assets. You will also be able to withdraw any subsequent earnings tax-free, if applicable requirements are satisfied.²

This method usually works well, but not always. Since no one knows how to choose the "bottom" of the market, the value of an IRA that is converted to a Roth may continue to decline. Therefore, it may be worth less than the market value that was reported — and taxed — when the conversion was done.

It's sometimes possible to deal with this problem by reversing or "recharacterizing" the Roth conversion. The assets are returned to a traditional IRA and you avoid taxes. You may also be able to perform another Roth conversion at a later date. The relevant tax rules are somewhat complex, however, so be sure to get help from a professional.

An Ameriprise financial advisor can help you determine if Roth conversions and contributions are right for you, and walk you through the process if it's appropriate.