Roth IRA Rules

Since 2010, anyone has been able to convert a traditional IRA to a Roth. But there are a number of rules you’ll want to know when making the switch.

How do I go about converting my traditional IRA to a Roth now that it’s 2010?

Anticipating a slew of conversions, most IRA administrators will make it easy for you to convert your traditional IRA to a Roth. Some (including Fidelity, Vanguard and T. Rowe Price) also offer handy tools on their Web sites to help you calculate your tax bill before you make the switch. Also see our Should I Convert My IRA Into a Roth IRA? calculator.

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First, you'll need to open a Roth IRA account if you don’t have one already. Then you'll fill out a conversion form to switch money from the traditional IRA to a Roth (some firms let you open the account and move the money all on the same form). You'll have to specify how much of the traditional IRA you want to convert, how the money should be invested in the Roth, and whether you want taxes withheld from the amount you move to the Roth. It's best if you can say "no" to withholding and pay the tax bill out of non-IRA funds. If you dip into the IRA to satisfy the IRS, you'll owe tax and, if you're younger than 59 1/2 an early-withdrawal penalty on the amount. If you make the conversion in 2010, you can spread the tax bill over 2011 and 2012.

If you're switching your IRA from one mutual fund company, brokerage firm or bank to another, you'll fill out most of the paperwork with the new IRA administrator, which can walk you through the process. But it’s a good idea to give the old firm a heads up so that the transaction will go smoothly.

My wife and I have traditional IRAs that we intend to convert to a Roth. We made the maximum contributions to them in 2009. Can we also make contributions to the IRAs for 2010 before we convert? My income is too high to qualify for Roth contributions.

You sure can. Even though there is still an income limit to contribute to a Roth IRA in 2010 -- your modified adjusted gross income must be less than $120,000 if single or $177,000 if married filing jointly -- the $100,000 income limit to be able to convert a traditional IRA to a Roth disappeared in 2010, giving everyone a back door into a Roth. You can now make your contributions to a traditional IRA and immediately convert them to a Roth IRA.

I haven't made IRA contributions over the past few years because I earned too much to contribute to a Roth and didn't qualify to make tax-deductible contributions to a traditional IRA. Now I wish I would have contributed to a nondeductible IRA anyway so that I could have converted it to a Roth. Is there anything I can do to catch up?

You still have until April 15, 2010, to contribute up to $5,000 to an IRA for 2009 (or $6,000 if you're 50 or older). You can also make your contributions for 2010, then convert the money to a Roth.

In your column in the January 2010 issue of Kiplinger's, you stated that "if you already have a traditional IRA, you can't simply put $5,000 into a nondeductible IRA and then move it tax-free to a Roth." Please explain again. I had contributed to a deductible IRA for many years, then stopped putting money into that account when I was no longer eligible for the deduction. I make too much money to contribute to a Roth, but I have been contributing to a nondeductible IRA for many years. I want to convert all of this into a Roth in 2010. I also want to contribute to the nondeductible IRA in 2010 and convert it into a Roth because I make too much to contribute directly to a Roth. Why can't I do this in 2010? My wife is in the same predicament.

Now that it's 2010, you can convert your traditional IRAs to a Roth regardless of your income. What I was referring to was the tax treatment of the conversion -- if some of your IRA contributions have been tax-deductible and some have been nondeductible, you can't just cherry-pick the nondeductible contributions to convert and avoid paying taxes.

Instead, the amount taxable on the conversion is based on the ratio of nondeductible contributions to the total balance in all of your traditional IRA accounts. If you have $10,000 in nondeductible contributions, for example, and the total balance is $12,000, then 83% of any conversion would be tax-free.

I am 68 with no earned income. Under the new law, can I convert a traditional IRA to a Roth and make contributions from investment income? If so, what are my limitations?

You don't need to have earned income to be able to convert a traditional IRA to a Roth. But you do need to have earned income to make new IRA contributions.

If you don't work but your spouse does, he or she can make IRA contributions on your behalf. If you and your spouse are both older than 50, you can each contribute up to $6,000 to an IRA in 2010 (although the total contributions cannot be more than your spouse’s earned income). You both can contribute to a Roth as long as the adjusted gross income on your joint return is less than $177,000 in 2010 (the maximum contribution starts to phase out if you earn more than $167,000).

My son is 17 and worked over the summer in a sunglasses shop. Can he open a Roth IRA?

As long as he had some earned income in 2009, he can open a Roth IRA and contribute up to the amount he earned for the year or $5,000 (whichever is less). If he doesn't want to use his own earnings for the Roth, you are allowed to give him the money to contribute to the account. He has until April 15, 2010, to contribute to an IRA for 2009.

The long-term benefits can be huge. If your son contributes $1,000 to a Roth IRA now and his investments return 8% per year, that $1,000 could grow to about $47,000 by the time he's 67 -- not counting any other money he adds through the years! He'll be able to withdraw the contributions at any time without taxes or penalties and can withdraw the earnings tax-free after age 59 1/2. See Why Your Kids Need a Roth IRA for more information.