Anyone Can Have a Roth IRA!
by Jessica Chiarantona

		Regardless of your income, you can convert part or all of your traditional IRA to a Roth IRA in 2010, spreading the income taxes over three years. Therefore, even if you earn too much to contribute to a Roth IRA from 2006 to 2009, you can make non-deductible IRA contributions and then convert these contributions to a Roth IRA in 2010 by paying taxes only on the income they have earned – in short, you can effectively make Roth IRA contributions, regardless of your income. If you’ve made deductible contributions to a traditional IRA in previous years, you will have to pay some taxes on conversion in 2010, and you will have to do some additional record-keeping until your traditional IRA is fully converted to a Roth, or exhausted.

Elimination of income restrictions on Roth IRA conversions

On May 17, 2006, President Bush signed into law the Tax Increase Prevention and Reconciliation Act of 2005. This new legislation eliminates the $100,000 AGI (adjusted gross income) limit on conversions from a Traditional IRA to a Roth IRA beginning after December 31, 2009.

Background

There are two types of IRA accounts; Traditional and Roth. Contributions to a Traditional IRA are deductible if certain criteria are met, while contributions to a Roth IRA are never deductible. All taxpayers are eligible to make nondeductible contributions to a Traditional IRA, regardless of AGI. This is not true for Roth IRAs. Allowable Roth IRA contributions phase out at the following AGI levels:

If you are ineligible to contribute to a Roth IRA and are an active participant in a qualified plan, SEP IRA, or 403(b), your contributions to a Traditional IRA are nondeductible.

Furthermore, taxpayers with AGI greater than $100,000 are not allowed under current law to convert a Traditional IRA to a Roth IRA.

What does the new Act mean?

The new act allows taxpayers with AGI above the limit to convert Traditional IRAs to Roth IRAs in 2010. The taxpayer will include the conversion amount ratably as income in 2011 and 2012 unless he or she elects to recognize it all in 2010.

What can you do now?

One way to take advantage of the new legislation before 2010 is to begin making nondeductible contributions to a Traditional IRA now and convert the contributions to a Roth IRA in 2010. You can contribute to a Traditional IRA for 2006 until April 15, 2007.

How does it work?

Example 1:

John and Jane (age 40) have a combined AGI of $175,000, making them ineligible to contribute to a Roth IRA. John is an active participant in a qualified plan. They do not have Traditional IRAs. They each decide to open a Traditional IRA today and make annual nondeductible IRA contributions through the end of 2009.

At the end of 2009, John and Jane have $36,000 total in their two IRA accounts (assuming no earnings). On January 1, 2010, they are eligible to convert their Traditional IRAs to Roth IRAs. They will pay no tax on this conversion (if there are earnings on their contributions, they will owe income tax only on the earnings). In effect, John and Jane have been able to make Roth IRA contributions every year from 2006 to 2009.

Example 2:

Bill and Lisa (age 40) have a combined AGI of $165,000, making them ineligible to contribute to Roth IRAs. Lisa is an active participant in a 403(b) plan. Bill already has a Traditional IRA account with a balance of $18,000 in deductible contributions. Bill decides to open a second IRA account today and plans on making annual nondeductible contributions through 2009.

Bill has total Traditional IRA contributions (deductible and nondeductible) of $36,000. In 2010, Bill wants to convert his nondeductible Traditional IRA contributions to a Roth IRA. Bill must look at his total Traditional IRA contributions when determining his tax liability.

When Bill converts $18,000 to a Roth IRA in 2010, he will owe tax on $9,000 of the $18,000 that he converts. This is because $9,000 is treated as nondeductible and $9,000 is treated as deductible. He will also have $18,000 remaining in his traditional IRA, of which $9,000 is considered by the IRS as non-deductible. He’ll have to track the non-deductible component until he withdraws it later in life, or until he converts it to a Roth, as well.

Example 3:

Same as above, except Bill has $180,000 in deductible contributions in his Traditional IRA.

When Bill converts $18,000 to his Roth IRA in 2010, he will be taxed on $16,364 because only $1,634 is treated as nondeductible.

Conclusion

If you are ineligible to contribute to a Roth IRA and do not have a Traditional IRA, it is clearly in your interest to open a Tradtional IRA today and begin making nondeductible contributions.

If you are ineligible to contribute to a Roth IRA, but you already have a Traditional IRA to which you have made deductible contributions, the benefit is smaller, unless you are willing to convert your entire IRA to Roth, and pay the implied taxes. Also remember that the more deductible money you already have in an IRA account, the more tax you will pay on your conversion to a Roth IRA.

Finally, if non-deductible contributions remain in your traditional IRA after conversion, you must keep track of them by filing Form 8606 annually.