New Tax Law - Roth IRA for Everyone?

[Guest wdc]

Looking for some confirmation here. The new tax law recently passed (Tax Increase Prevention and Reconciliation Act of 2005) makes Roth IRA conversions available to everyone beginning in 2010. Currently, if your Modified Adjusted Gross Income (MAGI) is over $100,000 you cannot convert assets to a Roth. Additionally, you cannot contribute to a Roth IRA if you make over $150,000 jointly. What's preventing a couple making more than $150,000 in income from funding a non-deductible IRA each year starting in 2006 and then converting the account to a Roth in 2010? Conceivably you could continue to do this every year - make a non-deductible IRA contribution and then immediately convert it to a Roth IRA. It basically opens up Roth for everyone! You would only have to pay taxes on any earnings on the regular IRA upon conversion if you made an after-tax IRA contribution. You would have thought the gov't would have noticed this loophole but you never know. Am I missing anything????

[namealreadyinuse]

It is not a loop-hole because it is intended to raise revenue to bring the rest of the tax bill in under 70 billion. The government wants you to do it, so they get the tax money up front although it will cost the fisc in the long run.

Recently, there has been a lot of debate about the wisdom of Roth treatment for high wage earners, so if you are in that camp, you probably aren't worried about a lot of people using the suspended agi limit.

[Guest wdc]

Good point on high wage earners and whether Roth is a good deal. Wonder why they just didn't make it easier for people and eliminate the MAGI restrictions in 2010 as well but that may have been too logical!

Obviously one of the nice benefits of Roth is the ability to avoid RMD thereby allowing wealthier investors to pass along more to the next generation. But, with a little creative estate planning (ie. using RMDs to fund a life insurance trust) you could probably get to a similar result anyways albeit with more cost / effort.

[Guest mjb]

From the Govt's point of view it is better to collect the tax $ upfront than wait until the future to collect it because it reduces the deficit in 2010, not 20 -30 yrs later when todays pols will not be in office. From the taxpayers point of view it is a gamble that he will be in a higher tax bracket in retirement than 2010 so paying taxes now reduces future taxes. If the taxpayer is in the same or lower tax bracket in retirement then in 2010 there is no reason to do a conversion because the taxpayer has lost the future value of the taxes paid as the opportunity cost for the Roth, E.g., $4000 roth contribution for taxpayer in 25% bracket =$1000 in taxes which @8% interest for 20 years would have a future value of $4661. Thus the fv of a 4000 roth contribution at 8% for 20 yrs would be 18, 644 which after reduction for the Fv of the taxes paid in 2010 is $13, 983. Compare this to pre tax contribuion of $4000 @8 x20 years which has a future value of 18,644 before taxes and 13,983 after 25% is paid in taxes or a reduction of $4661 which is the same amount of the future value of the taxes paid on the roth.

[txdd]

wdc:

The taxability of Roth conversions is based on the deductible/non-deductible history of ALL of an individual's IRA's. If you built up an IRA with deductible contributions in your old low-income days or you rolled over a large amount from an employer plan into an IRA, then most of the amount you convert to Roth will be taxable even if you start making non-deductible contributions now. This is true even if you keep your non-deductible IRA separate.

So for many if not most people, the new ability to Roth convert is NOT the equivalent of removing income limits on Roth contributions. Each individual's situation must still be considered to determine whether a Roth conversion is a good idea.