What is the 2010 Roth IRA Conversion opportunity?<br />
For the first time since the Roth IRA debuted in 1998, individuals with an Adjusted Gross Income (AGI) over $100,000 can convert all or part of their Traditional IRA into a Roth IRA. This means that higher wage earners now have the opportunity to convert their current tax-deferred retirement dollars to tax-free status upon retirement. The conversion may be a good option for those who think they’ll be in a higher tax bracket when they withdraw, don’t see themselves withdrawing funds for at least 10 years, and can pay the taxes due from sources other than the IRA.

When do I pay taxes on the conversion?<br />
You have the option to pay the tax in full in 2010 or to claim 50% of the conversion amount in 2011 and the remaining 50% in 2012 – but keep in mind that this special provision is only for those that convert in 2010. For conversions after 2010, taxes would be paid in full for the year in which the IRA is converted. If you decide to convert in 2010 and opt to split the taxes in 2011 and 2012, there are a couple of things you may want to keep in mind— the tax rate you pay would be determined based on your tax bracket for 2011 and 2012, and the current tax cuts are set to expire at the end of 2010.

Can I still contribute after the conversion?<br />
That’s the part that did not change. The phase out limits still apply when determining whether an individual is eligible to contribute to a Roth IRA for 2010. Individuals may make a partial or full contribution (up to $5,000; $6,000 for individuals age 50 and over) to a Roth IRA as long as their AGI falls below or within the phase out range. For single filers in 2010, the phase out limit is $105,000-120,000. For those filing jointly in 2010, the phase out limit is $166,000-176,000. Individuals above the limit are not eligible to make Roth IRA contributions.

What if I convert and later decide it wasn’t right for me?
Those who convert and then later change their mind can do a recharacterization. This allows the IRA owner to reverse the conversion completely and can be done until October 15th of the calendar year after the year the conversion took place. So, if you decide to convert in 2010 you would have until October 15, 2011, to recharacterize. IRA account holders are not allowed to reconvert back to a Roth IRA within the same tax year or within 30 days of a recharacterization.

Converting to a Roth IRA can get tricky, especially if you have multiple IRAs or only want to do a partial conversion. That’s why it’s important to discuss this with a tax professional to make sure you fully understand what the tax implications would be for your specific situation.

The IRS does not indicate what investments and transactions are allowable with IRA funds; instead they identify those that are prohibited. A Prohibited Transaction can bring into question the tax-deferred status of your IRA, potentially resulting in the disqualification of your account and substantial tax consequences. If it is determined that a Prohibited Transaction has occurred your IRA would be treated as a distribution as of the first day of the year in which the Prohibited Transaction took place.

What is a Prohibited Transaction?

Prohibited Transactions usually occur when the IRA engages in transactions with a disqualified person.

Who would be considered Disqualified Person?

• The IRA owner
• The spouse of the IRA owner
• Any lineal descendants and their spouses
• Any lineal ascendants and their spouses
• Investment advisors and managers
• Anyone providing services to the IRA such as a trustee or custodian
• Any entity in which any above person has a 50% or more interest

What Prohibited Transactions commonly occur?

• Borrowing money from your IRA.
• Selling property to your IRA.
• Receiving unreasonable compensation for managing an IRA asset, such as a rental property.
• Using your IRA as security for a loan.
• Buying property for personal use (present or future) with your IRA funds.

These rules were put into place for the IRS to ensure that all of the business conducted with the IRA is for the benefit of the IRA. Because the funds are intended for future retirement, actions that create an indirect benefit for the IRA owner could disqualify the IRA. Common examples of indirect benefits include:

• Indirectly tapping funds for personal use

If two or more IRA owners loaned each other funds to avoid a Prohibited Transaction it would be considered an indirect benefit.  The parties may not be on the disqualified persons list, but if a party indirectly benefits from the transaction, this action could potentially disqualify the IRA.

• Sweat equity

If your IRA holds a property that needs improvements, providing the labor or having another disqualified person or their company provide the labor would be a prohibited transaction.  You would also not be able to use any personal tools or equipment to improve a property held by the IRA.

It may seem like there a lot of rules to remember on what you cannot do with your IRA. But keeping your IRA from engaging in Prohibited Transactions is the best way to protect your interest in your retirement.  You can easily avoid Prohibited Transactions by following these three simple rules when contemplating a transaction in your IRA.

First, make sure that anyone your IRA will be doing business list is not a disqualified person.

Second, avoid investing in collectibles, S-corp stock or life insurance contracts.

Third, look closely at the potential transaction with your tax advisor to decide if it would result in an indirect benefit to you or any other disqualified person.

Following these steps can help steer you away from potential prohibited transactions while still leaving the door open for numerous investments.

More information on self directed IRA investment options and prohibited transactions can be found in our IRA Resource Center.