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  Building an IRA Nest Egg

Converting a traditional IRA into a Roth IRA can be a wise idea, depending on your circumstances. It's true that a conversion will trigger a current federal income tax bill, which is generally based on the balance of your traditional IRA reduced by any nondeductible contributions. However, the following benefits will likely make the transaction worth it:

Begin Planning for a Roth IRA Conversion Now!

Income Limits on Roth IRA Contributions

    The article to the left assumes that you’re ineligible to make annual Roth IRA contributions because your income is too high. The ability to make such contributions is phased out between modified AGI of $95,000 to $110,000 for unmarried taxpayers (between $150,000 to $160,000 for joint filers).
    Your eligibility to make annual Roth contributions is unaffected by whether you (or your spouse, if married) participate in an employer-sponsored retirement plan.
    Annual Roth IRA contributions are limited to the same amounts as traditional IRAs. Obviously, if you are interested and eligible to make annual Roth contributions based on your income, you should do that instead of contributing to a traditional IRA and converting.

  • Future income and gains earned in the Roth account are allowed to accumulate federal-income-tax-free.

  • Money in your Roth IRA can then be withdrawn federal-income-tax-free after the account is at least five years old and you’ve reached age 59 1/2.

  • In addition, your Roth IRA is exempt from the required minimum distribution rules which force you to begin taking annual withdrawals after age 70 1/2. In contrast, other tax-advantaged retirement accounts, including traditional IRAs, are subject to the mandatory distribution rules.

For these reasons, a Roth conversion can be a very attractive tax strategy.

Conversions are Currently Limited,
But Stay Tuned

There’s one big current problem with the Roth conversion idea for taxpayers with high incomes: You’re not eligible for the conversion privilege in any year that your modified adjusted gross income (MAGI) exceeds $100,000.

However, the new Tax Increase Prevention and Reconciliation Act, enacted in May, eliminates the unfavorable MAGI restriction. Unfortunately, this taxpayer-friendly change doesn’t kick in until 2010. So until then, the current $100,000 MAGI rule will continue to prevent higher-income folks from taking advantage of the Roth conversation strategy.

Is There Anything You Can Do Now?

If you want to plan ahead for the upcoming unlimited Roth conversion bonanza, you can do so by loading up your traditional IRA with as much money as possible between now and then. That way, you will have a substantial balance that can be converted to Roth status in 2010.

If you are in the high-income category, you probably can’t make any deductible traditional IRA contributions (see bottom right-hand box for the rules). But you can always make nondeductible traditional IRA contributions if you have earned income for the year and have not reached age 70 1/2. You can receive earned income from salary as an employee, from self-employment activities, or even from alimony payments made to you by your ex-spouse.

How much can you contribute to a nondeductible traditional IRA? For the 2006 and 2007 tax years, you can put in the lesser of:

1. $4,000 ($5,000 if you’ll be age 50 or older as of the end of the year) or

2. Earned income.

For 2008 through 2010, the amounts increase. You can contribute the lesser of: $5,000 ($6,000 for those age 50 or older as of year-end) or earned income. If you’re married, the same contribution limits apply to your spouse so he or she can fund a separate nondeductible IRA.

Therefore, if you are under age 50, you can contribute up to $23,000 for the 2006 through 2010 tax years ($4,000 each for 2006 and 2007 equals $8,000 plus $15,000 for the $5,000 contributions for 2008, 2009 and 2010). If you will be 50 or older at the end of all those years, you can contribute up to $28,000. The same goes for your spouse. Then in 2010, you can convert your nondeductible traditional IRA into a tax-free Roth account.

Assuming you have no other traditional IRAs (including SEP accounts and SIMPLE-IRAS), you would only be taxed on the earnings that have accumulated in your nondeductible IRA.

The deadline for making a nondeductible traditional IRA contribution for each tax year is April 15 of the following year (the date is extended until the next business day if it falls on a Saturday or Sunday). But you can also make your contribution for each year as early as January 1 of that year. Once you turn 70 1/2, you can no longer contribute to a traditional IRA.

But Will the Roth Conversion Rules
Really Change in 2010?

Skeptics have noted that Congress could decide to change its mind in the future and eliminate this favorable provision before it ever becomes effective. They argue that if there is a change of political power in Washington, it will not survive.

Even if you’re not convinced that the new Roth conversion rules will actually go into effect in 2010, following this strategy of putting the maximum in nondeductible traditional IRA contributions between now and then doesn’t have much downside. Why? Because you will at least get the advantage of tax-deferred earnings with a nondeductible traditional IRA. The chance to possibly convert the traditional account into a tax-free Roth IRA down the road is just icing on the cake. So if you want to plan ahead, there is no big reason not to do so, as long as you realize the possibility of political change. Ronald J. Cappuccio, J.D., LL.M.(Tax) 1800 Chapel Avenue West Suite 128 Cherry Hill, NJ 08002 Phone:(856) 665-2121      Fax: (856) 665-9005 Email:

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