Smart move: Converting traditional IRA to a Roth IRA

— -- Q: Due to my income level, I have been unable to contribute to a Roth IRA, so I have contributed to a non-deductible IRA. If I convert these to a Roth IRA, do I pay tax only on the gains?

A: Pat yourself on the back. Sounds like you're one of the few savvy investors to figure out how to fund a Roth IRA, even if you make too much to qualify for a Roth.

First the rules: You must make contributions to a Roth IRA using earned income that's already been taxed.

Because you've already paid taxes on the money, a Roth IRA is one of the best deals going. If you follow the rules, the money, including any earnings, is never taxed again. Traditional IRAs work just the reverse. You put untaxed dollars into a traditional IRA, then pay tax when you take the money out.

There are limits on a Roth. In most cases, you may contribute to a Roth if your modified adjusted gross income is less than $169,000 if married and filing jointly and $116,000 if you're single. You make more than the threshold.

But you were wise to set up a traditional IRA, even though you couldn't deduct your contributions. Why? A little-known change in the tax code will allow you to convert your traditional IRA to a Roth. And this is a good time to convert for many investors, because the stock market is still down a lot from its 2007 highs. You can read more here about why converting to an IRA to a Roth is attractive now.

Here's the hitch: Now, traditional IRAs can only be converted to Roth IRAs if the taxpayer's adjusted gross income is less than $100,000, says the PricewaterhouseCoopers' "2009 Guide To Tax and Financial Planning." That $100,000 limit applies whether you are single or married.

But the game changes in 2010, when the $100,000 limit for converting is removed. Suddenly, everyone no matter how much they earn can convert a traditional IRA to a Roth IRA.