Roth IRAs For Everyone!

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Back in May, legislation was passed that allows Traditional IRAs to be converted to Roth IRAs without any income restrictions in 2010. Previously, this conversion was only available to taxpayers with adjusted gross incomes of $100,000 or less, no matter if you’re married or single. You even get two years to pay the taxes on the conversion. One of the more detailed articles I’ve seen written about this change is this USA Today article.

Another side effect of this new law is that it opens up a gaping loophole so that allows anyone to contribute to an Roth IRA, albeit indirectly:

Congress didn’t change the income eligibility requirements for contributing to a new Roth IRA. Singles with AGI of more than $110,000 can’t invest in a Roth; for married couples, the cutoff is $160,000. But lifting the conversion cap would provide a way for high-income workers to bypass those limits. They could invest in a non-deductible IRA, then convert it to a Roth.

So if you’re making too much even this year, just contribute to a non-deductible IRA this year, and wait a little over three years until 2010 to roll it over. You’ll have to pay taxes on your earnings, but that’s fine since you’re still only paying taxes once – and now your entire balance can grow tax-free and remains tax-free upon withdrawal.

What’s the catch? Congress might change their minds before 2010:

Between now and 2010, lawmakers might decide that allowing high-income taxpayers to shelter millions of dollars from taxes isn’t fiscally prudent. The provision is expected to raise $6.4 billion over the short term, as savers pay taxes to convert their regular IRAs to Roths. But the Tax Policy Center, a non-partisan think tank, estimates that over the long run, the provision will reduce tax revenue by $16 billion.

Mel Schwarz, legislative director for Grant Thornton in Washington, thinks there’s a good chance lawmakers will revisit some of the provisions in the tax bill ? including the Roth conversion rule ? before they take effect.

In that case, you may be stuck with a non-deductible IRA, in which you’ll have to pay taxes upon withdrawal again but the earnings will compound tax-free. That’s may still be better than a taxable account if you stick all your bonds and REITs in there, so you won’t be giving up the 15% long-term capital gains rate.

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  1. This is great but will it work for employees who’s employers don’t offer the ROTH 401K?

  2. I don’t see why not?

  3. I was tempted by the conversion loophole until I started hearing rumblings about it being closed.

    But the risk that the loophole will be closed, leaving me with a traditional IRA with $12000 in it and the resulting unfavorable taxation, doesn’t seem worth the risk.

    On the other hand, if the loophole is still there come 2010, then it will certainly be worth jumping on.. I’d like to see them lift income limits for IRA contributions period. They’re just one more way the government discourages productivity.

  4. You said “You?ll have to pay taxes on your earnings, but that?s fine since you?re still only paying taxes once – and now your entire balance can grow tax-free until withdrawal.”, but the balance really grows tax free and withdrawals are also tax free — it’s a Roth, remember? I hope this loophole doesn’t get plugged!

  5. I have a roth and a non-roth IRA now totaling about $5000. They only make about $0.45 a month at Ameritrade. Is that normal? I could have that at Eloan and be making a lot more these days with that money.

    I’m trying to figure out what I can do with that $5000 to get it to be profitable.

  6. There’s one other risk, but it’s a risk that everyone who has or intends to invest in Roth IRAs face – the possibility that the money will become fully or partially taxable when you withdraw it.

    Yes, it’s true that as of right now it’s not taxable when withdrawn, but that too can be changed.

    Some of us can remember when we were told that Social Security would not be taxable when received, yet now up to 85% of it is taxable.

    —“A bird in the hand….”

  7. Whoa cowboy…the rollover is not as good as it sounds for those who already have substantial deductible IRA’s, SIMPLE, 401(k), etc.

    Assume because of your income you put the maximum into non-deduct IRA over the next few years. If that is all you have then the correct analysis is that you get to roll over all the non-deduct contirbs and only pay tax on the earnings to date. So if you contrib 20k and in 2010 it is worth can roll over the 20 tax free and only pay tax on the 5k…

    BUT.. and it is a big but…if you have any other pre-tax retirement savings plan (401k, SIMPLE, SEP, or an IRA when you were making less) then the rollover gets screwed….still may be worth it long term but short term it is not so good.

    When you roll over, even if it is all non-deductible contributions, you can only roll over and avoid tax on that percentage of your total assests in all combined retirment savings accounts that the non-dedcut contribs represent.

    The fomula looks like this

    After-tax Contributions / Total (non-Roth) IRA Assets

    For instance and to keep the math simple, as I understand it…if you have 100K in a 401k or SIMPLE or etc, that has been funded by pre-tax earnings that have been deducted…

    and lets say you have 20 K in an IRA that was funded with after tax income non-deducted…

    then applying the formula above

    20k / 120k = 16.6%…or the after tax IRA only makes up 16.6% of your total retirmeent accounts.

    Therefore when you roll over the 20k in 2010 only 16.6% of it will be considered tax-free from the after tax income IRA …the other poriton will be considered as having come from your other pre-tax IRA’s and you will still have to pay tax on the other 83%.

    You simply do not get to choose what slice of the pie gets to be a Roth.

    so in the above situaiton a 20k roll over is only worth about $3,300 non-tax and you will have to pay tax on the other $16.7k.

    Long term it may be worth it..but it is a much bigger short term tax bite then it sounds.


  8. fin_indie – That was worded improperly, I’ve fixed that, thanks.

    Gina – I know, a whole can of worms gets opened when you talk about what would be changed…

    1) Roth withdrawals could be taxed partially or completely (making Roths look worse)
    2) 15% Capital gains rate could decrease to zero, or go back to marginal rates.
    3) Income taxes could go a lot higher (making Roths look better)


    Steven – What you say about pro-rating when you don’t do a complete rollover is true, won’t argue with you there.

  9. Do you know what the maximum contribution is for a married couple to a Roth IRA account? Thanks!!

  10. Is anyone concerned about not being able to afford the taxes on the conversion? If you are making non-deductible contributions to a traditional IRA now and for the next several years, it probably won’t amount to anything too significant however I am planning/hoping to convert a prior employer 401k to an IRA and convert that. Say its worth $100k now, if things go well that could be $200k by 2010. Since none of it has been taxed, the entire account value has to be taxed upon conversion. Yes you can spread the tax payment over two years, but you are still talking about $30k per year. That’s $2,500 per month for 24 months. Ouch!

  11. Steven had some good points but only IRAs are counted in the bucket of pre-tax monies. SIMPLEs, SEPs, traditional IRAs, etc all count together and 401k and 403b accounts are not taken into the total. This means that if you were to leave your job, keep the money in the 401k, do the non-deductibe IRA conversion to the Roth, then roll over the 401k to an IRA.

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