As I’ve mentioned before, Roth IRA’s are a great investment tool to take advantage of when preparing for retirement. (If you don’t have one, you need to open a Roth IRA account right now.) This is largely due to the tax free benefit that is entitled to you once you take distributions from your Roth upon retiring. Unfortunately, for those that make too much money, they cannot contribute to a Roth. If you find yourself in this situation here are two ways that you may be able to take advantage of the tax free benefit. First, let’s look at the Roth IRA Phaseout Limits:
Roth IRA Phaseout Limits
Wage earners that are on the outside looking in when it comes to a Roth IRA didn’t get much help in the phaseout limits in 2010. Single filers received no improvement, while joint filers increased a whopping $1,000 to the bottom and top ranges.
2010 Roth IRA Phaseout Limits
Roth 401k, If You’re Lucky
One, if you are lucky enough to have an employer that offers a Roth 401(k), then you could benefit from the tax free benefit. With a Roth 401(k), there are no income restrictions, so any one can contribute. The only thing to be conscious of is that if you do participate in a Roth 401(k) and your employer matches, the employer match will actually go into the traditional 401(k), meaning that it will be pre-tax. So in essence, upon retiring, you will both have tax free money in your Roth and then the employer match would be taxable upon taking your distributions.
The 2010 Roth IRA Conversion Event
For those of us that aren’t lucky enough to have a Roth 401(k) at our work, then here is another option that you could take advantage of.
This year and next year, if you make too much money to contribute to a Roth, you could contribute to a non-deductible traditional IRA. For those under the age of 50, that’s $5,000. For those over the age of 50, that’s $6,000. So if you are over the age of 50, you can contribute $6,000 this year and $6,000 next year. Since it is a non-deductible IRA, you do not get an income tax benefit from doing so, but here is what you could do. By maxing out the contributions for the next two years and then come 2010 we have the 2010 conversion period, which will then allow you to convert your traditional IRA’s into Roth IRA’s. Doing so, you then just pay the tax on the contributions plus any interest earned in those two year periods, but you are then getting into a Roth IRA which then will give you the tax free money at retirement.
This is typically referred to as the “backdoor” into the Roth IRA. It’s a nice little loophole in case you are one of the unlucky ones who makes too much to contribute to a Roth IRA.
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{ 2 comments }
Hi Jeff,
If I read this right, do you mean that the contributions to the non-deductible IRA, upon conversion in 2010, will be double-taxed? (Since they were taxed in the years when you put them into the IRA – why it’s called non-deductible, and then taxed again when they are converted in 2010).
If that is correct, that doesn’t seem very fair. I can understand taxing the interest or gains.
Can we also convert traditional (deductible) IRAs to Roth IRA in 2010?
Elise-
The non-deductible IRA is just that, one that you don’t get a tax deduction for, but can still benefit from the tax deferral. In my own experience, many people did not take advantage until the 2010 conversion event became available.
In 2010, you would just pay the tax on any gains from the initial contributions. If you mean by double taxing as your contributions are after tax then you pay tax on the gain (if any), then that’s correct. But if you look at it as a way to get a pretty handsome chunk into a Roth IRA for some tax free money, when it was never an option before, that can be a nice little benefit.
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