non-deductible contributions to a Traditional IRA

[Beliavsky]

For households that have maxed out 401(k) contributions and have too
much income to make deductible IRA contributions, I have read
recommendations (at http://www.mymoneyblog.com/archives/2009/03/2008-2009-nondeductible-ira-contribution-limits.html
for example) to contribute to a Traditional IRA and to then convert to
a Roth in 2010. In 2010 there are no income limits on such
conversions.

Is this a good idea? I think it depends in part on what investments
one plans. IMO corporate bonds are an attractive asset class at
present, and they are best held in a tax-deferred account.

What is the chance Congress will change the rules for Roth conversions
in 2010? The linked article says that since Roth conversions generate
revenue in the near term, Congress will probably not change the rule.

 

[JoeTaxpayer]

For households that have maxed out 401(k) contributions and have too
much income to make deductible IRA contributions, I have read
recommendations (at http://www.mymoneyblog.com/archives/2009/03/2008-2009-nondeductible-ira-contribution-limits.html
for example) to contribute to a Traditional IRA and to then convert to
a Roth in 2010. In 2010 there are no income limits on such
conversions.

Is this a good idea? I think it depends in part on what investments
one plans. IMO corporate bonds are an attractive asset class at
present, and they are best held in a tax-deferred account.

What is the chance Congress will change the rules for Roth conversions
in 2010? The linked article says that since Roth conversions generate
revenue in the near term, Congress will probably not change the rule.

It depends - does the potential depositor to the IRA already have a
deducted IRA balance? If so, the Roth conversion is prorated.
e.g. I have $18,000 balance in my IRA, and no basis. This year I cannot
take any deduction, so I do $2000 in post tax money. In 2010, I cannot
just convert the $2000 tax free, any conversion is 90% taxable. This may
or may not be an issue, just a thing to be aware of.

As far as the congress question, who knows? Can anyone?
Joe

 

[Tad Borek]

recommendations to contribute to a Traditional IRA and to then convert to
a Roth in 2010. In 2010 there are no income limits on such
conversions.

Is this a good idea? I think it depends in part on what investments
one plans.

What is the chance Congress will change the rules for Roth conversions
in 2010?

The ideal case is someone with $0 in IRA assets now, who contributes
$10k ($5k self, $5k spouse) for 2008-10, all nondeductible, and then
coverts it all. The contributions establish "IRA basis" so the
conversion would be taxable only to the extent of any income earned. And
if that's a concern for whatever reason, you could leave it in money
market, earning spit until then.

After that you'd have a pool of (ostensibly) tax-free dollars to invest.
It wouldn't matter what you invested in really; tax-free beats taxable,
assuming you don't need the cash for something else and the money will
sit awhile.

As for whether the rule could change - while it's possible I haven't
heard of anything in committee that would mess with it (Roth limits are
a bit obscure, as a tax issue). Over-$250k households do seem to be in
the gunsights though, even if the outcome is potentially better if given
a tax provision like this. It should raise some extra tax revenue in
2010, but at the possible cost of less down the line, with the biggest
benefit falling on higher-net-worth taxpayers. I suspect though that
many who convert would have been better off leaving the dollars as
pre-tax money; on the numbers, most IRAs aren't going to be big enough
to be taxed much during retirement (if at all).

-Tad

 

[BreadWithSpam]

The ideal case is someone with $0 in IRA assets now, who contributes
$10k ($5k self, $5k spouse) for 2008-10, all nondeductible, and then
coverts it all. The contributions establish "IRA basis" so the
conversion would be taxable only to the extent of any income
earned. And if that's a concern for whatever reason, you could leave
it in money market, earning spit until then.

Or someone who expects his income to go down significantly so
that he can do the conversion during a year of low AGI and
thus low taxes on the conversion. Someone who spends much
of a year out of work between jobs, perhaps, or who expects
to start his own company and for it to take a while to
become profitable. (Or, of course, if someone starts his own
company and it is profitable, he may consider setting up
his own 401k anyway - very possibly with Roth and non Roth
contributions).

the biggest benefit falling on higher-net-worth taxpayers. I suspect
though that many who convert would have been better off leaving the
dollars as pre-tax money; on the numbers, most IRAs aren't going to be
big enough to be taxed much during retirement (if at all).

True for a great number of folks out there, many of whom
may be overestimating their future retirement wealth and
income.

We've discussed here the advantages and disadvantages of
non-deductible contributions before. I still lean towards
favoring them for those not eligible for Roths for a variety
of reasons, even without any consideration of the possibility
of conversions. Certainly I'd rather see folks make
non-deductible IRA contributions before they start getting
sucked into VAs generally.

 

[Will Trice]

It depends - does the potential depositor to the IRA already have a
deducted IRA balance? If so, the Roth conversion is prorated.

This makes the decision dependent on the size of the deductible IRA
balance, too. To get the full benefit of the rolling over
non-deductible contributions in 2010, you'll have to rollover your
entire Traditional IRA balance.

The dominant factor in deciding whether a Roth conversion is beneficial
is typically the difference between your current marginal tax rate and
your marginal tax rate at withdrawal. But if your deductible IRA
savings are large (say from a big 401(k) rollover, or whatever), then a
conversion in 2010 could dramatically alter your tax landscape in
retirement. Now it's not just your marginal rate in retirement that's
important (which is already impossible to predict), but your overall
effective tax rate - probably hard to even get reasonably close.

For myself, I've elected to put funds that might have gone into a
non-deductible IRA into a taxable account instead.

-Will

william dot trice at ngc dot com

 

[Ron Peterson]

For households that have maxed out 401(k) contributions and have too
much income to make deductible IRA contributions, I have read
recommendations (athttp://www.mymoneyblog.com/archives/2009/03/2008-2009-nondeductible-i...
for example) to contribute to a Traditional IRA and to then convert to
a Roth in 2010. In 2010 there are no income limits on such
conversions.

It's a good idea, and I think that if your 401(k) doesn't have
matching funds, you should max out your IRA first. Regular and Roth
IRAs give greater investing flexibility.

Is this a good idea? I think it depends in part on what investments
one plans. IMO corporate bonds are an attractive asset class at
present, and they are best held in a tax-deferred account.

Don't buy bonds in a company that's close to bankruptcy.

What is the chance Congress will change the rules for Roth conversions
in 2010? The linked article says that since Roth conversions generate
revenue in the near term, Congress will probably not change the rule.

I think you're right on that. So don't convert too much getting
yourself a higher tax rate or AMT.