Some new changes in the law mean upper-income individuals should again consider contributing to a non-deductible IRA. In 2010, they will be able to convert their IRAs to Roths regardless of their income level. And they will be able to spread the tax over 2010 and 2011.
Let's assume you are 25 and make a single $4,000 Roth contribution. Because of compounding, your single $4,000 contribution will grow to $64,000 by age 61 ($128,000 by age 70).
At age 61, the major portion of the Roth will be your earnings ($60,000) because your contribution was only $4,000. In a Roth, this $60,000 of growth is tax-free when you withdraw it. Also the Roth has no mandatory withdrawal at age 70 1/2 .
In a traditional IRA, all of the $64,000 would be taxable at ordinary income rates. Since we now have the lowest tax rates in years, I would assume the tax rates will perhaps be much higher at your future withdrawal date. The Roth withdrawals are completely tax-free. With a Roth, you didn't receive a tax deduction for the original $4,000, but you don't owe any tax on the $64,000 withdrawal.
With tax rates very low and the probability of higher taxes in the future, funding the Roth is a great idea. Most of you are at the 15 percent to 25 percent tax bracket. I've seen the top rate at 70 percent.
So it is probably a great idea to fund your Roth each year. This might be true even if you have to cut back some on your contribution to the company pension plan (always fund up to the company match first).
Some of you have large (or small) amounts of dollars in traditional IRAs. Perhaps you rolled your company retirement plan into your IRA. You can "convert" part or all of your IRA to a Roth. You pay tax on the amount you "convert." Think of what will probably happen to these dollars. Many of you are not using those dollars. Most will be inherited by our children. The children generally cash out the IRA or Roth immediately. With an IRA, it means the children will pay tax at their highest rate on the IRA. Again, if it was a Roth, no tax would be due by the children.
This means you pay the tax now rather than leave the "tax bomb" for your children. And you probably pay it at a lower rate than your children would. Even if this isn't an issue for you, you still should consider "converting" enough dollars from an IRA to a Roth each year to maximize your 15 percent to 25 percent tax bracket.
Many of our higher income clients would like to contribute to a Roth or convert some of their IRAs but they can't because of the income limitation. A couple can only contribute to a Roth if the income is less than $160,000. If a taxpayer's income is greater than $100,000, you can't convert to a Roth. But the recent tax law provided a window during which everyone can convert regardless of income level in 2010. Talk to your financial advisor about how you might be able to take advantage of this law change.
Patricia Bliss, CPA and CFP, is an investment adviser with Linsco/Private Ledger in Olympia. She can be reached at 360-754-0490 or www.lpl.com/patricia.bliss.