Roth IRA Conversion Limits Going Away

I’ve mentioned this in passing before, but I thought it was worthy of a post of its own… In case you haven’t heard, with the passage of the Pension Protection Act of 2006, the income limits for converting traditional IRA funds to a Roth IRA are slated to go away in 2010.

What this means is that, unless Congress closes that loophole, Roth IRAs will essentially become available to everyone at that point, regardless of how much money you make. The reason for this is that you’ll be able to make a non-deductible contribution to a traditional IRA (there are no income limits for this) and then turn around and convert those funds to a Roth IRA.

In fact, if you’re willing to roll the dice, this bit of information could help you out right now… If you’re like us, and your income currently exceeds the limit for Roth contributions, you can simply make non-deductible traditional IRA contributions and then wait for 2010. At that point (once again, assuming Congress doesn’t close the loophole) you’ll be able to convert your funds to a Roth. Because the original contributions were non-deductible, you won’t owe any taxes on that portion of your money. Of course, if your investments grew in the interim (and hopefully they will), you’ll owe income tax (but not penalties) on that fraction of your money.

The only downside here is what happens if you the loophole goes away… In that case, you’ll have locked your money away in a traditional IRA without receiving the up front tax deduction that lower income individuals receive in return for their contributions, and you’ll also miss out on the tax-free distributions at the back end of a Roth IRA. The big bummer here is that traditional IRA distributions are taxed as income, which means that capital gains housed within such an account are taxed at a higher rate (upon distribution) than they would have been had they been held outside an IRA. Thus, a tax-efficient portfolio that focuses on capital gains (which are only realized upon liquidation) and minimizes taxable distributions might be a more attractive alternative.