As you probably already know, the tax law is changing in 2010 to remove the current restriction for making traditional IRA to Roth conversions. Currently, individuals with modified adjusted gross incomes in excess of $100,000 cannot do a conversion without incurring a 10% penalty if they are younger than 59 1/2 years old. Additionally, taxes are due in the year of conversion on any pretax savings and accumulated growth. In 2010, the income limitation is being removed allowing anyone to make a Roth conversion without incurring the 10% penalty. Taxes would still be due as before however there will be an option to pay these in equal installments over the two years following the year of conversion.

Already, financial product salespeople are touting the advantages of Roth conversions in anticipation of 2010 by emphasizing the tax advantages Roth IRAs have over traditional IRAs. Unlike withdrawals from traditional IRAs, Roth withdrawals in retirement are tax-free. Another key advantage of the Roth is that there is no requirement to begin taking withdrawals after one reaches the age of 70 and 1/2, as is the case with traditional IRAs. This “required minimum distribution” (RMD) feature of the traditional IRA forces taxpayers to make taxable withdrawals from their accounts regardless of actual income need. Roth IRAs do not require RMDs, thereby allowing the taxpayer the option of leaving assets in the Roth to potentially appreciate over a longer period of time.

Unfortunately, financial product salespeople often do a better job promoting the potential advantages of Roth conversions than they do the more important job of assessing whether a Roth conversion is appropriate for an individual client. The answer is not clear-cut by any means and a careful analysis must be performed to make an informed decision. Factors that must be considered are current and anticipated future income tax brackets, the source of assets available to pay the tax due on the conversion, and projected income needs in retirement. This is not a straightforward analysis. Additionally, there is the element of the unknown with regard to future tax law changes that further complicates matters.

In many cases, the result of a careful analysis will be that a partial conversion is the optimal course of action, both for empirical reasons as well as a hedge against future tax law changes. The ability of a client to pay the taxes due upon conversion may also weigh in favor of the partial conversion strategy.

Clearly, this is an area fraught with traps for the unwary and no one-size-fits-all solution exists. Advisors seeking to maximize the business opportunity presented by this tax law change while failing to properly assess the appropriateness of a Roth conversion on a case by case basis do their clients a disservice. Undoubtedly, a tax planning opportunity exists for some in 2010. Advisors who truly put their client’s interests ahead of their own, however, need to be prepared to tell some of these clients that a Roth conversion is not appropriate in their particular case. Those of us who understand that providing good advice, and not selling products, is the best value we can offer clients will be more likely to engage in the thoughtful analysis required by the Roth conversion opportunity in 2010.