As of right now, those who file jointly, with Modified Adjusted Gross Incomes of over $160,000 ($110,000 for single filers) cannot contribute to a Roth IRA. They may still contribute to a non-deductible traditional IRA. However, the problem with this is that there’s no tax benefit upfront and the withdrawals will be taxed at retirement.
In a few years there will be a way around all this! Here’s how:
According to the Tax Increase Prevention and Reconciliation Act of 2005 (here’s a link to a Wikipedia entry on the act) that was signed into law earlier this year, beginning in 2010 conversions to Roth IRAs will be allowed by anyone, regardless of income. As of right now, conversions are only available to those with Modified Adjusted Gross Incomes of less than $100,000. So, until then, a person could contribute to a non-deductible traditional IRA for 2006 – 2009 and then convert that IRA to a Roth IRA in 2010 and pay the income tax on the conversion in 2011 and 2012.
Keep in mind that those who do the conversion will have to pay ordinary taxes on everything but your original contributions (known as basis). So, if a person contributes $4,000 per year to a non-deductible traditional IRA for years 2006 – 2009, their basis is $16,000. If the account is worth $25,000 in 2010 when they convert it to a Roth IRA, they will have to pay ordinary income taxes on $9,000 ($25,000 – $16,000 = $9,000). But, the taxes on that $9,000 can be spread out over two years (2011 and 2012), which will add $4,500 to income over those two years.
Who would want to do such a thing?
- Young high-income earners who have a long time until retirement.
- Those who like the the flexibility of the Roth IRA. For instance, with a Roth IRA there is NEVER a required minimum distribution unless the Roth is inherited. Also, Roth IRA withdrawals DO NOT count when figuring taxation on Social Security benefits during retirement.
- Those who think they will be in a higher tax bracket during retirement.
I’m sure I’ll be writing more on this in the future.