IRA/Roth IRA Strategy

[Guest S J]

Hello everyone!

I need some help. I currently have a traditional IRA that I have already contributed $2K for 2001. The balance is around $7,000 and I'm 32 yrs old.

I have already sent in my tax return for 2001 to the irs.

I'm interested in opening a Roth IRA before April 15th (I know I'm cutting it close . If I open a Roth for year 2001 will I need to pay tax on that for 2001. If so is there an irs tax form for this?

OR Is it better to wait until after April 15th and open it for 2002?

Also, I was thinking since the market is down I might want to convert the traditional IRA to a Roth. I would do this conversion after April 15th. What is the penalty for this and is this a good idea?

Or should I just keep the traditional IRA .. let it accrue and start a Roth IRA also.

Is there an advantage to having both besides being able to save more? or disadvantage if any.

thanks for your help!

[papogi]

The total amount you can contribute in 2001 to all of your IRA's (traditional and Roth) is $2000. Since you have already contributed $2000, you can't open a Roth for 2001. If you did, this amount would be considered an excess contribution and would be subject to a 6% penalty yearly until you correct the error. With that said, you could then just open a Roth IRA for 2002. Actually, you can open a 2002 Roth IRA anytime between 1/1/02 and 4/15/03.

Converting to a Roth is usually a good idea for most people, but not everyone, depending on certain circumstances. Generally, it is recommeded, however, especially since you have many years until retirement. There is no penalty to convert. You just have to understand that the $7000 in your Trad IRA will be taxable income on your 2002 taxes (that is, if the contributions you put into that account have been completely tax-deductible). Roth IRA's are to be made up of after-tax dollars. This is how they are tax-free upon qualified withdrawals.

Having both a Trad IRA and Roth IRA does not allow you to save more. The 2002 annual limit is $3000, and this is an aggragate allowance for all of your IRA's. It's not $3000 here and $3000 there.

Without knowing your details, I would recommend converting your Trad IRA into a Roth IRA, setting aside the extra money you'll need at tax time to cover the tax on the conversion (a little under $2000) then seeing if you can free up any more money to add a 2002 contribution to the account as well.

[Guest S J]

Thanks papogi ... that was a big help!

One more question.

Does the tax I pay on the conversion to a Roth depend on my tax bracket or is this a set % of the total amount in the IRA? You said approx. < 2,000 on a 7,000 balance.

thanks again

[papogi]

The tax on your conversion is based on your marginal tax bracket. The $2000 estimate was just that, an estimate. If your $7000 Trad IRA account is made up entirely of tax-deductible contributions, then the entire amount becomes taxable income, taxed at income tax rates, on line 15b of your 2002 1040. If you have any non-deductible contributions in your Trad IRA, that amount will be reported on form 8606, and only the taxable portion (account surrender value minus non-deductible contributions) should be on line 15b.

[Guest S J]

Understood... thanks!