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7 steps to a 2010 Roth IRA conversion

Many tax advisers agree that for a Roth conversion to make sense, you should be able to pay taxes from your income or another source, not from funds taken from your IRA.

"If you're thinking about cashing in part of your IRA to pay the tax bill on it, forget it," Savant Capital's Lindell says. "You're defeated already."

That's because you'll have to pay interest and penalties on any IRA funds you remove from your account to pay taxes. Paying the taxes from your IRA account also will reduce your balance and your ultimate nest egg when you retire, he says.

Step 6: Consider when to convert

For many taxpayers, it makes sense to convert as early in 2010 as possible to gain as much possible from the tax-free growth that a Roth offers. However, if you're unsure of what your income will be and what tax bracket you'll be in, it makes sense to wait until the second half of 2010 to get a better handle on the tax consequences, says Sadler.

And don't forget, there are no income limits beginning in 2010. So if you wait to convert, you can do it regardless of your income.

Step 7: Fill out conversion paperwork

The conversion paperwork isn't that complicated. If you have made nondeductible contributions to your IRA, you will need to know how much you contributed in nondeductible contributions, which you can find in your income tax forms on Form 8606, Nondeductible IRAs.

You'll need to let the custodian of your IRA -- the mutual fund, bank or other financial services company that holds your account -- know certain information, including:

  • How you want your converted assets invested.
  • Whether you will pay the taxes due yourself or want the custodian to withhold the amount from the IRA's assets to pay them.
  • Who you want to name as a beneficiary to receive the money upon your death.

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