I love Roth IRAs. The problem has always been qualifying for the darn things.
Well here’s your chance to move some of your income into a Roth IRA without worrying about qualifying.
Backround
Roth IRA s are fabulous for two reasons. First, withdraws from Roth IRA s are tax free. When does that ever happen? The initial contribution to a Roth IRA is not tax deductible but everything it ever earns will never be taxed again.
The second reason I love Roth IRA s is that there are no required minimum distributions (RMD). For other IRA s (and 401k plans), you are required to begin taking minimum distributions when you reach 70 ½ years old. You have to take the money out of your tax deferred accounts and pay income taxes whether you need the funds or not.
The bulk of funds saved for retirement are in tax deferred accounts that will be subject to income taxes when distributed. Suppose you want to buy a car (or replace your roof) in retirement but all your money is in a tax deferred portfolio. A large withdrawal will move you into a higher tax bracket. Wouldn’t it nice to have a pool of funds that can be accessed without any tax ramifications?
To qualify for a Roth IRA contribution in 2006 your income must be less than $150,000 if married filing jointly ($95,000 if single or head of household). You can make a partial Roth IRA contribution up to $160,000 income for MFJ and $110,000 income for Single or HOH. The income limitations have gone up in 2007. For MFJ the 2007 income limitation is $156,000 to $166,000 and Single and HOH are $99,000 to $114,000.
In order to convert your tax deferred IRA to a Roth IRA your income has to be less than $100,000. Income taxes are due on the amount converted. Typically, conversions only make sense if you have the funds to pay the income taxes outside the IRA. Few people making less than $100,000 a year have the additional funds available to pay a substantial tax bill making Roth IRA conversions impractical.
The Roth IRA Strategy
If you are below these income limitations, you (and your spouse) should be making Roth IRA contributions or considering a conversion. If you currently exceed the 2006 and 2007 income limitations for Roth IRA contributions or conversions, here is a strategy that will get you in the game.
Last year Congress passed legislation that abolished the Roth IRA income limitations for conversions in the year 2010. What good does that do me know you might ask?
Making contributions to a non-deductible (non-traditional) IRA and then in 2010 converting the balance to a Roth IRA is a fabulous strategy. The original contributions would not be subject income taxes at conversion because you already paid income taxes when you contributed the funds to the non-traditional IRA. However, any money earned in those few years would be subject to income taxes. It is not too late to establish a non-traditional IRA and make a contribution for 2006.
If you are less than age 50, you can make the maximum contribution to a non-traditional IRA each year up to 2010. So you would be able to contribute $4,000 in 2006, $4,000 in 2007, $5,000 in 2008, $5,000 in 2009 and another in 2010. Please note: If you are age 50 or over, you are eligible to contribute an additional extra catch-up amount of a $1,000 a year.
As a married couple, you will be able to move more than $50,000 into a Roth IRA. As it stands now, this loop hole is available in 2010. Conversions can be tricky so make sure you understand all the rules or hire a professional. It is a great strategy it just takes a little work to execute but it is worth it.
Libby Mihalka
The Financial Pragmatist
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