It depends on your age, your appetite for investment risk, and whether or not you have cash available in a non-retirement account to pay the income taxes that will be due on the conversion.
The main advantage of a conversion is that neither you nor your heirs will ever have to pay income taxes on money earned in the Roth IRA. The main drawback: when you do the conversion, you'll have to pay income taxes on the amount of money you convert.
Conversion eligibility is limited to taxpayers whose annual household income is 100,000 or less. (The money you're converting will be added to your annual income for tax purposes, but it doesn't count toward this $100,000 ceiling.)
When calculating their annual household income to determine eligibility for a Roth conversion, retirees must include their mandatory distributions from traditional IRAs and qualified retirement plans but only until December 31, 2004. After that date, mandatory distributions will no longer count toward the $100,000 ceiling on conversions.
Unlike the decision to open a new Roth IRA, a Roth conversion isn't a no-brainer. However, it's certainly worth considering:
All withdrawals from a converted Roth IRA are taxfree after you've owned the account for five years and are over age 59 and a half. If you're over 59 and a half, you can withdraw your principal i.e., the money you put in tax-free no matter how long you've owned the account. If you're under 59 and a half, you'll owe a 10 percent penalty on principal withdrawn within five years of doing the conversion.
You never have to tap a Roth IRA: It can pass income tax-free to your beneficiaries. (Your spouse can roll your Roth IRA into a Roth of his or her own. A non-spouse beneficiary must empty your account over his or her lifetime.)
By contrast, a traditional IRA is only tax-deferred. All your withdrawals are taxable as ordinary income, and there's a 10 percent penalty on money taken out before you're 59 and a half. After you turn 70 and a half, you must take money out of a traditional IRA every year.
But a Roth conversion isn't free: You pay income taxes on the money you convert. (There's no 10 percent early-withdrawal penalty on this money, regardless of your age, as long as it goes into a Roth IRA.) The conversion makes sense only ifyour tax-free Roth IRA earnings will more than make up for the the tax going in. That depends largely on your answers to the following questions:
Can you pay the taxes on the conversion out of a non-IRA account?
If not, it's probably not worth doing. Let's say you have $100,000 in your IRA and the tax on the conversion is $30,000. If the taxes come out of the $100,000, you'll deposit only $70,000 into the Roth IRA. And if you're under 59 and a half, you'll owe a 10 percent early-withdrawal penalty on the $30,000 you're using to pay the taxes an extra $3,000 cost.
How long will your money grow tax-free in the Roth IRA?
If you're under 45, or intend to leave the Roth IRA untouched for your kids or grandchildren, the conversion makes more sense than if you'll have to start emptying the account in just a few years. And how aggressively will you invest the account? The more you can expect to earn in a Roth IRA, the more sense the conversion makes.