The benefits of Roth IRAs can be easily summarized: tax-free income, no required distributions. For the most part, though, those benefits have been tantalizingly out of the reach of clients with six- and seven-figure incomes, the ones who would gain the most from those advantages. That's about to change. Starting in 2010, anyone can convert a traditional IRA to a Roth IRA, regardless of income. What's more, in 2010 only, taxpayers who convert can choose to defer the resulting taxable income to their 2011 and 2012 tax returns, in a 50-50 split.

The bottom line is a harmonic convergence for Roth IRA conversions in 2010: no income requirements, tax deferral and relatively low IRA balances on which to owe taxes, thanks to the market downturn. Financial planners and clients need to tune in to the potential tax fallout of the conversion and prepare to take full advantage of the possibilities.

"A lot of clients don't understand the difference between a Roth IRA and a traditional IRA," says Kelly Campbell, who heads a wealth management firm in Fairfax, Va. "You may have to do a great deal of explaining so that they understand the advantages and disadvantages of a conversion."

TAX TREPIDATION

The major disadvantage of a Roth IRA conversion is the need to pay tax much sooner, and in larger lumps, than one would otherwise have to do. For example, let's take John Smith: At age 50, he can let his $100,000 traditional IRA sit for a couple of decades, tax-deferred, before he needs to take required minimum distributions. Why should he pay as much as $35,000 to the IRS now, just to convert that account to a Roth?

"A lot of clients rethink a Roth IRA conversion when they find out how much tax they'll have to pay," says Bryan Place, a financial planner in Manlius, N.Y. "They have the mistaken belief that it has to be all or nothing." In fact, Place says, all of the Roth IRA conversions he has facilitated have been partial conversions. A client with a $100,000 IRA might convert, say, $20,000 in a given year and thus report $20,000 of taxable income.

To help move Roth IRA conversions along, Place has built relationships with CPAs. "The CPA might tell the client, if you convert $10,000 you'll owe this much tax, if you convert $20,000, you'll owe that much tax and so on," Place says. "We could provide estimates ourselves, but numbers from a CPA may be more precise and may have more credibility with clients."

Place also notes that CPAs who are asked to do projections may discover other clients who could benefit from Roth IRA conversions, including partial conversions. "We've added financial planning clients in this manner," Place says. "Working with CPAs on Roth IRA conversions can be a huge value added for all the parties."

Cheryl Holland, president of Abacus Planning Group in Columbia, S.C., adds that it's a good idea to keep a client's CPA informed about Roth IRA conversion plans, regardless of whether the accountant is involved in determining the amount to be switched over. "Sometimes we'll work with a client's CPA and sometimes we'll come up with our own suggestion," she says. "Either way, we try to find a sweet spot for the amount of the conversion."

That sweet spot might be the amount needed to fill up the 25% tax bracket. In 2009, a married couple filing jointly can have taxable income up to $137,050 and remain in the 25% federal bracket; in the next few years, that number probably will creep up a bit. Therefore, if a married couple has projected taxable income of, say, $110,000, they might convert $25,000 or even $30,000 from their traditional IRAs to Roths and owe only 25% to the IRS.

DIVIDE AND CONQUER

Partial Roth IRA conversions will be especially attractive to high-income, high tax-bracket clients. If a client's effective income tax rate is 40% (federal, state and local), for example, converting an entire $500,000 IRA in 2010 would generate $200,000 in taxes. Even split between 2011 and 2012, that's one heck of a hefty tax bill.

David John Marotta, president of Marotta Asset Management in Charlottesville, Va., uses what he calls "Roth segregation accounts" to get the most mileage from a partial conversion. If you have multiple asset classes in one Roth, the tax effects of losses and gains are proportional to the account. But if you maintain multiple Roths, each with a single asset class, a client can pick and choose recharacterizations to take maximum advantage of the tax break.

Marotta converts the entire traditional IRA to five Roth IRAs of equal size, each of which holds a different equity asset class. For example, a $500,000 traditional IRA would be converted into five $100,000 Roths holding domestic large-caps, domestic small-caps, foreign stocks, emerging- markets stocks and hard asset stocks, respectively. This is a temporary allocation designed to get hyper-returns from one or more asset classes.