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Last year, many investors got their first opportunity to participate in one of the biggest retirement boons ever. But even if you didn't jump at the chance to convert all or part of your traditional retirement accounts to a Roth IRA in 2010, you can still do so this year and get many of the same benefits that early-adopters reaped last year.

Why the Roth rules
When Roth IRAs first became available more than a decade ago, they changed the landscape for retirement savings. Until then, retirement saving revolved around the concept of deferring compensation: taking income that would otherwise be taxed today and putting it in a sheltered account where it could grow on a tax-deferred basis until you withdrew it after you retired. At that point, the IRS finally gets its share, as you have to include withdrawals from regular retirement accounts in your taxable income.

Roth IRAs, on the other hand, turned that thinking on its head. You don't get a tax break for contributing to a Roth, and doing a Roth conversion actually creates tax liability today. But in exchange for paying the piper now, you get what potentially could be much more valuable: true tax-free growth for as long as the money stays in your Roth account.

Last year, income limitations disappeared for Roth conversions, so now anyone can have a Roth account. The only difference between this year and last is that with 2010 conversions, you were allowed to spread out the resulting taxable income between 2011 and 2012. With a 2011 conversion, you don't have that option; you have to include converted Roth money on this year's tax return.

The best thing about Roth conversions
The biggest benefit of converting to a Roth, however, is the ability to get a "do-over" if things don't work out well. Any time between when you convert and October 15, 2012, you can decide to undo your conversion.

That gives you a free opportunity to shoot for the fences with Roth money. If your investments shoot up in value, then you keep your Roth and get those gains tax-free, paying tax only on the original amount you convert. If they fall, however, you can do what's called a recharacterization and not have to pay any tax on the conversion at all.

The ability to get a Roth do-over leads to some specific investing strategies for newly converted Roths:

  • One idea is to put highly speculative stocks with binary outcomes, such as ImmunoGen (Nasdaq: IMGN  ) or Seattle Genetics (Nasdaq: SGEN  ) , in a Roth. The risk is still high, but if things work out well -- as they did recently for triglyceride-treatment maker Amarin (Nasdaq: AMRN  ) -- you don't have to share your profits with the IRS.
  • A somewhat less risky strategy involves putting beaten-down stocks with high growth potential in your newly converted Roth. For instance, Dolby Labs (NYSE: DLB  ) has suffered from the move away from PCs, but with opportunities from mobile apps and even automobile sound systems, the company could rebound quickly. Similarly, Teva Pharmaceutical (Nasdaq: TEVA  ) has suffered from the same patent worries that plague larger competitors Pfizer (NYSE: PFE  ) and Eli Lilly (NYSE: LLY  ) , but Teva's strong generics business should insulate it from the full brunt of problems going forward.

These are just some ideas, but if you have aggressive investments on your radar, the main point is that they're highly suitable for a newly converted Roth. It's rare to get a heads-I-win/tails-you-lose opportunity like this, but the Roth conversion and recharacterization rules make it possible.

Make the right move
So if you haven't looked into doing a Roth conversion yet, it's not too late. With current low tax rates set to expire at the end of 2012, converting to a Roth now before a potentially huge tax increase may bring you big savings in the years ahead.

Want to know more about how to handle your retirement accounts? Tune into our IRA Center and get all the facts fast.

Fool contributor Dan Caplinger can't say he makes all the right moves, but he does his best. He doesn't own shares of the companies mentioned in this article. Pfizer is a Motley Fool Inside Value selection. ImmunoGen is a Motley Fool Rule Breakers pick. Dolby Laboratories is a Motley Fool Stock Advisor recommendation. The Fool owns shares of Teva Pharmaceutical, which is a Motley Fool Global Gains choice. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy shows you the way.

Read/Post Comments (1) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 29, 2011, at 8:02 PM, kurtdabear wrote:

    When dealing with a morally and fiscally bankrupt government, I think you're better off getting your tax break up front. I can easily picture the government setting up a special category of "Alternative Minimum Tax" for Roth investors a few years down the road. After all, the Alternative Minimum Tax was instituted so the government could wring tax revenues out of people who had been using perfectly legal strategies to minimize taxation. The government has also repeatedly changed the rules of Social Security to the detriment of recipients, including taxing payments to those who make more than a few bucks a year.

    Further, if you're in the 28% tax bracket at the margin--which is where your extra investible income will come from--you have to earn nearly 40% on the 72% you have left just to get back to even. That will take an above-average investor more than 3 years to accomplish.

    Also, if it turns out you're not quite as great an investor as you thought you were, you'll probably wind up paying taxes at a lower rate on distributions from a regular IRA than the rate you would have paid on the money going in. And if you're fortunate enough to be a truly gifted investor and make a fortune, you'll be able to afford to pay taxes in a higher bracket.

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