So why wouldn’t you convert all of your traditional IRA holdings to Roth IRA accounts right away?  Well, there are a few catches, perhaps the most noticeable of which is that you’ll have to pay ordinary income taxes on any funds you convert to your Roth IRA rollover account.  Let’s look at a few situations in more detail to see where a rollover IRA to Roth IRA conversion makes sense for you:

Do you qualify for a conversion?

Great news – you do qualify, in light of recent IRS changes!  In the past, only account holders with an adjusted gross income (AGI) of less than $110,000 (single or head of household filers) or $160,000 (married couples) were eligible to contribute to Roth IRAs.  Now, however, even taxpayers with higher AGIs can convert funds to Roth accounts, provided they’re already in traditional IRAs.

Do you have the funds available for any applicable conversion taxes?

When you perform a Roth IRA conversion, you’ll be liable for income tax on any earnings or pre-tax contributions in your traditional IRA account, as you’ll have to claim the converted amount on your annual tax returns as income.  If you’ve only got a few thousand dollars socked away, this may be only a minor inconvenience, but if your traditional IRA account balance is much larger, you could be looking at several thousand dollars in tax penalties alone.

On the positive side, the recent IRS changes discussed above also offer some relief to taxpayers facing large tax penalties from Roth IRA conversions.  According to the new Roth IRA conversion 2010 rules, you’ll be able to spread your conversion over two tax years, lessening your tax burden significantly.

Another thing to consider when looking at Roth IRA conversion taxes is whether or not the added income will disqualify you from other federal and state tax benefits.  When you convert funds from your traditional IRA to a Roth IRA, you’ll receive a Form 1099R from your account provider.  Income entered from this statement is counted as general income on your tax return, causing your AGI to go up.  This increase may make you ineligible for other credits – such as child care or education programs – resulting in a net loss to you.

How close are you to retirement?

If you’re nearing retirement age, there are a few things you’ll want to consider before converting.  First of all, your traditional IRA balances are likely much larger than those who are just starting their retirement savings, which will lead to larger tax consequences, as discussed above.  Keep in mind that you’ll have less time to recoup these losses if you’re already close to retirement age.

Additionally, consider whether or not you expect your tax bracket to fall once you enter retirement.  If, for example, decreases in your AGI cause you to move from an effective tax rate of 28% to 15%, it makes no sense to pay taxes on these funds up front instead of later on when you begin taking distributions.