How high earners can grab a Roth IRA

If you make too much money to open a Roth IRA, a new tax law has created an attractive loophole.

Unlike traditional IRAs, Roths allow after-tax contributions to grow and be withdrawn tax-free. Historically, many successful business owners haven't been able to take advantage of Roths because their income was too high. Next year, as in past years, you must earn less than $116,000 as an individual or less than $169,000 as a couple to be eligible to open a Roth. Similarly, under current law, you are not eligible to convert a traditional IRA to a Roth if you earn more than $100,000 a year.

But in 2010 the salary limit for conversions expires, and the back door opens - meaning that from that year forward anyone can convert a traditional IRA to a Roth IRA, regardless of income. What's the catch? Well, because traditional IRAs hold pretax dollars and Roth IRAs hold after-tax dollars, you will have to pay taxes immediately on the money you move into the Roth.

It may seem counterintuitive to pay taxes right away when they could be deferred. Most financial planners argue that it makes more sense for younger investors to roll over into Roths and incur the income tax hit, because they have a long time horizon to enjoy the tax-free growth.

There's another factor to consider: tax rates. Because of the growing national deficit and recent corporate bailouts, many experts believe that higher income and capital gains tax rates are inevitable next year.

The deal is further sweetened by a provision that income taxes triggered by a Roth conversion in 2010 need not be paid all at once. As a one-time benefit for the first year the law changes, the taxes can be spread over 2011 and 2012. For example, if you convert a $100,000 traditional IRA to a Roth IRA, you would normally trigger a tax bill of $35,000 (assuming a 35% tax bracket). But if you make the move in 2010, you will be able to declare $50,000 of the income in 2011 and the other $50,000 in 2012 - in effect, getting a one-time, interest-free loan from Uncle Sam.

The new Roth loopholes are an obscure fringe benefit of the Bush administration's tax cuts. When Congress extended the cuts in 2006, the Roth rollover measure was enacted as a revenue raiser. Of course, the limits on income remain if you want to open a new Roth IRA. So here's a strategy that some planners recommend - you will have to act fast - instead of opening a Roth directly. You can open a SEP IRA (a traditional IRA for the self-employed) in 2008. This year and next, you can fund your new SEP to the limit of 25% of income, up to a maximum of $46,000. You'll deduct the amount you contribute from your 2008 and 2009 taxes, but set aside money to pay the tax in 2011 and 2012 - after you convert the entire amount to a Roth in 2010.

You should also do some planning to minimize your 2010 income, perhaps by taking some of it in 2009 instead. You may have to use the back door to take advantage of a Roth IRA, but in these uncertain times you should grab any advantage you can. Please contact out office if you wish to do any tax planning for 2009 or 2010 concerning this or any other new tax law. Our number is (214) 827-9118.

Source: Jeanne Lee CNN Money

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