Roth IRA Conversion Strategy to Avoid Taxes
As 2010 approaches, many people are positioning themselves to take advantage of the Roth IRA Workaround: 2010 Conversion Limit Loophole.
2010 Roth IRA Conversion
Normally there is a $100,000 income limit (MAGI) on the ability to convert from a traditional IRA to a Roth IRA. 2010 is the year that the limit disappears. In addition, you can spread the tax payment for a 2010 conversion out over two years. It’s a retirement jackpot (well, not really, but it is exciting!) for people that haven’t been able to contribute to a Roth IRA in the past.
Roth IRA Conversion Strategy to Avoid Taxes
Jim at Blueprint for Financial Prosperity wants to take advantage of the 2010 Roth IRA conversion loophole, but could face hefty taxes on his portion of the deductible IRA, since you must convert a pro-rata amount of deductible and non-deductible money.
This can be avoided! If your 401k provider allows transfers of IRA money, you can transfer your deductible IRA money to your 401k. When you convert your remaining non-deductible money in your traditional IRA to your Roth IRA, it will be tax free!
How it Works:
- Contribute to a non-deductible traditional IRA in 2008 and 2009.
- Move your deductible IRA money to your 401k late in 2009.
- Convert your non-deductible traditional IRA to a Roth IRA in 2010.
- Report your conversion with 100% basis at tax time for tax free treatment.
More Considerations
Which IRAs count? As with anything tax related, there are some tricky situations to avoid. The traditional IRA includes your SEP IRA and SIMPLE IRAs too. Don’t forget to account for all of your IRA money when you determine how you might make this work.
Don’t have a 401k? You could establish a solo 401k for the purpose of moving your deductible money in your traditional IRA. Lucky me, I just opened my new solo 401k a few weeks ago (in case you missed it on Twitter!)
Early Retirement and Roth IRAs. This strategy sounds like a lot of work to move money into a Roth IRA…. why would you want to hassle? If you are considering an early retirement, the Roth allows much more flexibility in early withdrawals than a traditional IRA. After a conversion, you only need to wait 5 years, then you can withdraw your conversion money tax free. A real benefit for anyone considering early retirement!
More on Roth IRAs:
- Unconventional Roth IRA Strategy to Lower Tax Bill
- How to Make Early Roth IRA Withdrawals
- Roth IRA Conversion Rules Highlighted
- How to Track Your Roth IRA Contributions… and Why You Need To!
- Strategy to Contribute More Than Roth IRA Limit Allows
- 2008 Roth IRA Limits
This is an excellent strategy, but I did have a question.
I thought that while withdrawing the principle out of a Roth IRA was tax free, but any interest you may have earned was not?
September 11th, 2008 at 10:34 am
Good suggestion; I would only caution people to consider investment options and expenses before using this strategy. For example, all of my IRAs are with Vanguard in Index Funds. If I were to move them into my 401K, the options would be MUCH fewer, and the expense ratio would be much higher. Of course, this is only my scenario, but I would argue that most people don’t have the range of choices and options for low expense funds in their 401K as they do for IRAs.
September 11th, 2008 at 11:47 am
Don’t forget, contributions to a Roth account can be withdrawn at any time penalty-free. The 5 year seasoning period only exists on certain transactions.
September 11th, 2008 at 1:20 pm
@ Jenna: Here are the rules on the withdrawals: How to Make Early Roth IRA Withdrawals.
November 20th, 2008 at 1:41 pm