In 2005, a little-known change in the tax law will let more people, primarily older and wealthier retirees, take advantage of moving funds from their traditional IRA to a Roth IRA.

For many, a Roth IRA is preferable to a traditional IRA, primarily because of the tax-free earnings on distributions if the Roth IRA is established for at least five years and the distributions are taken after age 59 1/2. Additionally, if you have earned income, Roth IRA contributions can be made indefinitely, regardless of age. One of the most attractive features of a Roth IRA, unlike a regular IRA, is the fact that there are no required minimum distributions once you reach age 70 1/2.

And this is where the new law change has a major impact. Most retirees fund their Roth IRA by moving (converting) funds from their traditional IRA to their Roth IRA. A conversion isn't allowed if the modified adjusted gross income is greater than $100,000. (Adjusted gross income is your taxable income less any amounts being converted from an IRA to a Roth IRA.) This threshold is the same for all, regardless of filing status.

Because of this limitation, many who were taking required minimum distributions from their traditional IRAs were finding that those distributions were pushing them over the $100,000 limit, and were then barred from converting those funds to their Roth IRA. For example, a person with regular income of $85,000 and a required minimum distribution of $20,000 could not make a conversion because their income exceeded the $100,000 threshold.

But the new law allows you to ignore the amount of the required minimum distribution when computing your threshold income. In 2005, using the example above, a conversion would be allowed since the $20,000 minimum distribution will not be counted in computing the $100,000 limitation. Therefore, many older individuals will be able to grow their Roth IRAs by converting traditional IRA funds.

Of course, most funds converted from a traditional IRA to a Roth IRA are treated as taxable income. Because of the taxability of the conversion, some shy away from moving funds from their IRA to a Roth IRA. But this might be shortsighted. It's possible to plan your conversions in years when your income is minimized. And the use of a Roth IRA as part of an overall estate plan can be very powerful, since the Roth IRA funds (unlike a traditional IRA) can pass through to beneficiaries tax-free. Also, since there is no required minimum distribution, the Roth IRA can be passed on and continue to grow tax-free, possibly for decades.

If your plans to convert funds from your traditional IRA to a Roth IRA have been stymied in the past because of the income limitations, you should pay careful attention to the new rules that might remove the roadblocks from making such conversions.

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