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8 Roth IRA conversion traps to avoid

Converting your Individual Retirement Account funds into a Roth IRA has never been easier -- but that doesn't mean it's right for everyone.

The IRS opened up Roth conversions to everyone this year regardless of income and introduced a three-year window in 2010 to pay taxes on the conversion.

It's a great opportunity to put together tax-free retirement income, but it's not without its perils. Bankrate.com spoke with IRA expert Ed Slott about some of the traps taxpayers might not be aware of -- and the dangers associated with them.

Trap No. 1: Watch out for conversion taxes

Many people are under the impression that you're able to split the taxes that come with converting a traditional IRA over a two-year period. That's wrong. It's the income from the IRAs that can be split.

That means the taxes could be wildly different on that income, depending on changes to the tax laws and your own salary and bonuses. As you decide whether to pay one lump sum or split it, it's smart to keep an eye on your tax bracket and make some educated guesses about how it could change in the coming years.

Trap No. 2: Don't use IRA funds to pay

The lure of tax-free retirement income is strong, but you may face substantial taxes on money you convert. Sometimes, those taxes are more than people can afford.

Let's say it's a $100,000 IRA being converted. Some people won't be able to pay the taxes on that, so they'll put $80,000 in the Roth and save $20,000 to pay the taxes. Bad idea.

"Money that's converted is exempt from penalties," says Slott. "But if you use part of it to pay the tax, there's a penalty if you're under 59½. It's something people don't think about -- and it's too late when the tax bill comes."

Trap No. 3: Other benefits could be lost

The money you convert from a traditional IRA counts as income on your taxes -- and that can impact your near-term future spending plans.

For example, if you're about to buy a home, converting to a Roth could cost you the $8,000 homebuyer tax credit being offered by the government. Or if your college-age child is looking for financial aid, the sudden surge in your income could dramatically hurt his or her chances.

Trap No. 4: Some premiums will increase

Those higher income levels from your conversion will also mean you take a hit on Social Security and Medicare premiums. The threat of that could scare people away from converting, but that's the real trap.

Those higher premiums aren't as bad as they seem. Yes, you'll take a hit for a year or two, but you'll never have to deal with them again. If you stick with a traditional IRA, you'll have to pay higher premiums for both programs every year once you hit 70½.

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