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March 2007
CONTRIBUTE NOW AND ROLL OVER IN 2010 BUT BEWARE OF UNEXPECTED TAX CONSEQUENCES
Income limits (modified AGI of $100,000 or less) on conversions of traditional IRAs to Roth IRAs are eliminated starting after 2009. Thus, taxpayers may make such conversions without regard to their AGI. For high income taxpayers who are not able to contribute to a traditional or Roth IRA, contribute to a nondeductible IRA now. Then, in 2010, you can convert that nondeductible IRA into a Roth regardless of your AGI. Only the earnings on the nondeductible IRA will be taxable. In addition, the tax can be spread over the following 2 years, 2011 and 2012. But be careful, if you have other IRAs, there is an "ordering rule" on basis and the results will not be as attractive for someone who only has a nondeductible IRA.
Example - nondeductible IRA with other IRA accounts. Julie, who is 50 or older, contributes $5,000 to a nondeductible IRA in 2006 and 2007. She contributes $6,000 in 2008 and 2009. In 2010, when the balance in her nondeductible IRA is $26,000, she converts the entire account into a Roth IRA. Because Julie has $100,000 in traditional IRA accounts, only $4,540 [(22,000/126,000) x $26,000] of basis is allocated to that account. Thus she'll pay tax on $21,460 ($26,000 - $4,540). However, if she had no other IRA accounts, she would only owe tax on the $4,000 of earnings in the account.
Therefore, taxpayers with traditional IRA account balances may want to roll these over into other pension accounts (like a profit sharing or 401(k)) and perhaps solve the 2010 tax problem when converting the nondeductible IRA to a Roth. Likewise, taxpayers with only nondeductible IRAs who plan to roll over funds from a former employer's 401(k) plan to an IRA may benefit from delaying the rollover until after 2010.
Individuals may make contributions to their IRAs until the due date of their tax returns (e.g., if the contribution is made by April 15), it will be treated as having been made on December 31 of the tax year for which the return is filed.
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