Many clients are still sitting precariously on the fence, trying to decide whether a 2010 Roth conversion makes sense. As the year winds down, they will be asking their financial advisors if they should take the plunge before Dec. 31. Their major concern? If they do decide to convert to a Roth, where would they get the money to pay the tax?

Time could be running out for these uncertain clients, however. Roth conversion tax planning for many individuals will be more expensive and less effective after 2010. As of October, it appears that the top federal income tax rates of 35% and 33% will rise to 39.6% and 36%, respectively in 2011.

Therefore, clients who convert a traditional IRA to a Roth IRA in 2010 and choose to include the conversion income in 2010 may pay tax at the lowest rates they'll ever see. After the conversion, there will be no required minimum distributions (RMDs), and the account will grow income tax-free for both the Roth IRA owner and his or her beneficiaries. Also, remember that a Roth conversion can be undone (recharacterized) up to Oct. 15 of the year after the conversion.

After years of income limits, Roth IRA conversions are now open to all taxpayers, including those high-income clients who stand to gain the most from such maneuvers. While the Roth conversion is not right for everyone, advisors must have this conversation with every client who qualifies.

If you are not having this conversation with your clients now, some other advisor no doubt will be jumping in, hoping to lure them away from you. The potential tax benefit is just too big to ignore.

THE RIGHT CHOICE

The key is to identify which clients will benefit most from a 2010 Roth conversion and take action now to plan out the most efficient and low-cost conversion possible. Whether clients pay tax for 2010 or spread the tax burden between 2011 and 2012, they'll owe income tax on pretax money they move from a traditional IRA or company plan to a Roth IRA. Where will they get the money to pay the tax?

One choice, of course, is to pay the tax from the traditional IRA. That's generally not a good idea, however, since then not all of the funds are working for the client in the Roth IRA.

In addition, if the client is under age 591/2, he or she would be subject to the 10% early withdrawal penalty on the funds not converted (the funds used to pay the tax). That, of course, is a poor use of funds. Even if the client is already 591/2 years old or older, any funds that are not converted (i.e., used to pay the tax) cannot be recharacterized if the client later decides to undo the 2010 Roth conversion.

If a client does not have enough non-IRA funds to pay the tax on a Roth conversion, the conversion generally won't be worth it. In some cases, a conversion should be avoided altogether, while in other cases, converting smaller amounts may be the right move. Smaller annual conversions can still add up to big sums of tex-free money over time.

FINDING THE MONEY

The most tax-efficient option is to find non-IRA cash to pay the tax on a Roth IRA conversion. However, finding funds to pay the tax on a conversion may not be easy. When you discuss this with clients, you might start by compiling a list of a client's financial assets and dividing those assets into four categories:

* Cash. This category includes already-taxed funds such as money market funds and bank accounts (but not IRA or other tax-deferred accounts). Withdrawals from these funds will not generate any tax, so all of the funds can be put to work to pay the Roth conversion tax.

* Capital gains assets. These include stocks, bonds, mutual funds and real estate. Clients may have paper profits on some of these assets, paper losses on others.

* Tax-deferred assets. IRAs and 401(k)s go into this category. If clients take money from these accounts, they will owe income tax at ordinary income tax rates and perhaps a penalty, depending on their age.

* Tax-free assets. Roth IRAs belong in this bucket because they can generate tax-free distributions, after the five-year and age 591/2 requirements are met. The same is true for life insurance proceeds. But many clients prefer a Roth IRA because they will have easier access to the money, if needed.

Generally, clients will do best to take money from one of the first two categories (cash and capital gains assets) to pay the tax on their Roth IRA conversions. Doing so will maximize the amount they can move into the fourth (and most desirable) category-a potentially tax-free Roth IRA.