“Ask an Expert” is a recurring feature on Bucks in which you have the opportunity to question big-brained individuals about a particular area of personal finance or consumer affairs.

Starting this year, anyone can convert a traditional individual retirement account to a Roth I.R.A., including those with adjusted gross income of more than $100,000. Those people were previously unable to reap the benefits of a Roth.

But deciding whether to make conversion can be confusing and involve weighing the immediate income tax cost of converting with the benefit of tax-free compounded growth that you can get with a Roth, as well as examining your own circumstances. at the same time, if you know you want to convert, figuring out the best method and timing for the conversion and sorting through all the paperwork can be confusing.

Ed Slott, an expert on I.R.A.’s, is answering your questions about converting to a Roth I.R.A. he is no longer accepting new questions.

Mr. Slott is a professional speaker and the author of the monthly newsletter Ed Slott’s I.R.A. Advisor and a number of books about saving for retirement. he has also created I.R.A. training programs and workshops to educate financial advisers about I.R.A.’s, and public television specials to educate the public. he is a past chairman of the estate planning committee of the New York State Society of Certified Public Accountants and editor of the I.R.A. planning section of the CPA Journal.

I understand that you can make a Roth conversion starting in 2010, and taxes on the conversion will be deferred for two years. that is, you will not have to pay taxes on the amount converted in 2010, 2011 all the way to April 2012. is that so, and is it on the full amount of the conversion or do you have a three-year spread as was the case in years before? Posted by Rob, New York, N.Y.

Not exactly. the way it works is that if you convert in 2010, you can spread the conversion income over 2011 and 2012, reporting half the conversion income in each year. under this option, you do not have to report any of the 2010 Roth conversion income in 2010. you pay tax only on the amount that was actually converted, not on any earnings within the Roth I.R.A. the conversion income is taxed as ordinary income.

Example: you convert $300,000 of your traditional I.R.A. to a Roth I.R.A. in 2010.

Result:
2010: you report no income from this Roth conversion
2011: you report $150,000 (one-half) of the Roth I.R.A. conversion income at the tax rates in effect for 2011
2012: you report $150,000 (the remaining half) of the Roth I.R.A. conversion income at the tax rates in effect for 2012

Or , if you wish, you can always elect to report the entire $300,000 conversion income on your 2010 tax return if you feel it will cost you less than reporting the income in 2011 and 2012 at potentially higher tax rates that will be in effect for those years.

What is a quick and easy way to estimate what the tax hit would be if I and/or my spouse converted our traditional I.R.A.’s into Roth I.R.A.’s? (I understand the tax can be paid out over two years, yes?) Posted by Jay, Princeton, N.J.

Unfortunately, when it comes to taxes, nothing is quick and easy. Income from a Roth conversion is taxed at ordinary income tax rates, the same as income from wages, interest and most other items. So keep that in mind when estimating how much more in tax a Roth conversion will cost you.

If you convert in 2010, you can report half of the conversion income in 2011 and the other half in 2012. you would pay the tax at the tax rates in effect for 2011 and 2012. Those rates are scheduled to rise from the 2010 tax rates. you do not have to include any of the 2010 Roth conversion income on your 2010 tax return. Or if you wish, you can elect to report all of the conversion income in 2010, if you feel that you will pay at lower rates in 2010.

To estimate the amount of tax your will eventually pay on a Roth I.R.A. conversion, you first have to have an idea of how much your regular income and deductions would be without the Roth conversion income. Then, add the income from the Roth I.R.A. conversion to that amount and do a projection (a make-believe tax return) to see how much the additional conversion income will increase your tax bill or by how much it could throw you into a higher tax bracket. This projection can be done with any tax preparation program. Or ask your tax accountant to run this for you. This will only give you an estimate, but at least you’ll have some idea what to expect.

A simple way to do this is to figure out from this projection, what tax bracket the conversion income would put you in and multiply the conversion income by the tax bracket since the conversion income would be taxed at that rate. for example, if the conversion income moves you to a 25 percent tax bracket, you can roughly estimate that adding $100,000 of Roth conversion income will cost you at least an additional $25,000 in tax. It will probably cost a bit more based on the amount you are converting and the types of deductions, exemptions, tax credits and other tax benefits you claim since an increase in income often causes these benefits to be reduced (in tax jargon it’s called “phased out”) increasing your overall tax bill. A large conversion, for example, could not only move you to a higher tax bracket, but the conversion income could also cause you to lose certain tax deductions, which in turn increases your taxable income.

I am 68 years old and have about $1 million in my I.R.A. Since the expectation is that income tax rates will increase beginning in 2011, should I convert to a Roth in 2010? What are the pros and cons of a conversion? Posted by AFN, Fort Worth, Tex.

Generally if you are converting in 2010, it would be best to defer the income to 2011 and 2012 under the special provision allowing 2010 conversion income to be reported one half in 2011 and the other half in 2012. This way you can hold on to your money for as long as possible before handing it over to Uncle Sam. It’s true that tax rates are scheduled to increase after 2010, so you could get hit with higher rates, but you will pay the tax later holding on to your money longer and hopefully earning tax free income during that time.

To decide whether to report the conversion income in 2010 or over 2011 and 2012 (at potentially higher tax rates), you’ll have to estimate what your tax rate might be in 2010, as opposed to 2011 and 2012. you may have heavy deductions or lower income in some of those years. for instance, even though the 2011 and 2012 tax rates will be higher, if you have lower income and higher deductions for those years, your actual tax could be lower based on these other factors. the reverse is true as well. Even though you do not have to include the 2010 conversion income on your 2010 tax return, you may want to if your 2010 tax comes out much lower than it would for 2011 and 2012. you will have to look ahead to all three years and see which option is best.

The good part is that you do not have to make that decision until you file your 2010 tax return. It is not due until April 15, 2011. you could actually file an extension until Oct. 15, 2011, and not make the decision until then. but watch out: If you use the extension, you should still pay in any 2010 tax you might owe by April 15, 2011, to avoid a potential underpayment penalty (if you later decide on your extended 2010 return to report the 2010 conversion income on your 2010 tax return).

Should you convert to a Roth I.R.A.? you need to address these three factors:

The first factor is the one you mention: What do you expect future tax rates to be? If you expect future tax rates to increase as I do, then it pays to convert to lock in today’s relatively lower tax rates. If you think you will be in a lower tax bracket in the future, then it does not pay to convert. the biggest negative of a Roth conversion is that you have to pay tax up front. but that tax will eventually be paid at some point even if you do not convert.

If you do not convert, you will be forced to withdraw from your I.R.A. anyway when your reach age 70½ (which is coming soon for you) and pay tax at the rates in effect at that time. Once you begin taking required minimum distributions after 70½, you must continue taking these distributions every year for the rest of your life whether you need the money or not. the Roth conversion removes this annual requirement since no distributions are required from your own Roth I.R.A. during your lifetime. yes, you do have to pay the tax on the conversion, but once it is paid, the account can grow free of income taxes, and your Roth I.R.A. will be forever shielded from expected future tax increases.

The second factor to consider is when you will need to access this money. If you will need the money to live on, then you should not pay tax now to convert if you are simply going to withdraw it within five to 10 years after conversion. the cost is not worth the benefit if you are not counting on keeping the Roth funds long term. the power of the Roth I.R.A. comes in long-term income tax free compounding.

If you do not expect to need the funds for many years, or maybe not at all, the Roth conversion becomes a terrific estate planning move since your Roth I.R.A. can be inherited income tax free by your children or grandchildren. Once they inherit, they will be subject to required minimum distributions, the same as if they inherited a traditional I.R.A., except that these distributions will be tax free and they can spread them out over their lifetimes, assuming you name them on your Roth I.R.A. beneficiary form.

The third factor to consider is whether you have the funds available in non-I.R.A. accounts to pay the tax. If you don’t have the money outside of your I.R.A. to pay the tax on the Roth conversion, then a conversion may not be for you. you don’t want to go broke converting. but this is not an all or nothing proposition. you don’t have to convert all of your I.R.A. to a Roth. you can do smaller, partial conversions over several years, lowering the cost of conversion each year.

The biggest benefit to a Roth conversion is that once the funds are in a Roth I.R.A., they do not have to be withdrawn in your lifetime and they grow income tax free forever.

In addition, once you convert, you have until Oct. 15 of the year after the conversion to undo it (it’s called a “recharacterization”). If you convert in 2010, you have until Oct. 15, 2011, to change your mind and reverse the process. that adds flexibility and reduces the market risk of a Roth conversion, at least until the time to “recharacterize” expires.

In an environment of rising taxes, it’s a smart move to protect your retirement savings from those tax increases, and that is exactly what a Roth I.R.A. does for you. the Roth I.R.A. removes the uncertainty of what future tax rates might be.

Answers About Roth IRA Conversions: Part 6