Although Roth individual retirement accounts (IRAs) offer some nice tax advantages, high earners have not been able to use them effectively due to tax law restrictions. In 2010, this law will change.
What Roth IRA’S Have to Offer: Roth IRA contributions are not tax deductible, so taxpayers get no immediate benefit from contributing. But account earnings are not taxed and earnings can be withdrawn tax-free once the account owner is at least age 59 and five years have elapsed from the year of the first Roth contribution.*
Individuals who prefer to leave their money invested can do so. The tax law’s minimum distribution rules don’t apply until after the account owner’s death and, even then, beneficiaries can typically stretch account withdrawals over their life expectancies. With its years of tax-free earning potential, the Roth IRA can be a good deal for taxpayers.
Restrictions: Taxpayers need to have earned income to contribute to a Roth IRA. Even with earned income, taxpayers can’t contribute to a Roth IRA if modified adjusted gross income (AGI) exceeds $110,000 ($160,000 for married-joint filers).**
Roth IRA Conversions: A traditional IRA can be converted to a Roth IRA by paying taxes on the balance, less any amount attributable to nondeductible contributions. However, if modified AGI, not including income from the conversion, is more than $100,000, a conversion isn’t permitted. Married individuals making a conversion must file a joint return.
These limitations will no longer apply starting in 2010. Anyone with a traditional IRA will be able to convert it to a Roth IRA, regardless of income or filing status. And, while 2010 seems far off, there is something high earners can do now to make the most of the liberalized rule.
The Strategy: Contribute now to a traditional IRA, then do a post-2009 Roth conversion. There are no income restrictions on nondeductible traditional IRA contributions, even for participants in employer-sponsored retirement plans. The tax payable on a conversion may be small due to the nondeductible nature of the IRA contributions. IRA earnings through 2009 will be taxed. After conversion, all earnings on the Roth IRA balance will be tax-free if you meet the distribution requirements.
* Tax-free distributions are available in certain other situations as well.
** If AGI is between $95,000-$110,000 ($150,000 and $160,000 for married-joint filers), a partial contribution is allowed
For more information please call Theresa Stewart at 661-775-9534.