You’re standing on the edge of the 10-meter diving platform ready to take the plunge into Roth IRA conversion waters, about to transfer 100% of your traditional IRA to a Roth IRA. Before you take that final step, there’s one more thing that you should consider if you’re still working or planning on working in the future and your income exceeds certain limits.
If you’re converting your entire traditional IRA to a Roth IRA, it doesn’t have to be, and in many cases shouldn’t be, the last Roth IRA conversion that you will do. In 2010, if you’re single and your modified adjusted gross income (“MAGI”) exceeds $120,000 or if you’re married and your MAGI exceeds $177,000, you’re prohibited from making direct contributions to a Roth IRA. It’s important to keep in mind that if your income doesn’t exceed these limits and you make a contribution to your Roth IRA, the maximum allowable amount is currently $5,000 or $6,000 if you’re 50 or older, and, furthermore, your contribution isn’t deductible.
While your income may limit your ability to make direct contributions to a Roth IRA, you may still make indirect contributions via a two-step process. In order to implement this strategy, you need to have a traditional IRA account in place. I recommend to all of my working clients who are considering full conversion of their traditional IRA’s to Roth IRA’s to keep one of their traditional IRA accounts open by leaving $1,000 in it. If you do this, even though you may be transferring 99% of your traditional IRA to a Roth IRA, you’re technically doing a partial, vs. a full, Roth IRA conversion.
Assuming that your income exceeds the specified deductible IRA contribution limits which in 2010 are $66,000 if you’re single and $109,000 if married, step one is to make a nondeductible IRA contribution to your traditional IRA account. The maximum allowable traditional IRA contribution, whether it is deductible or nondeductible, is identical to the maximum allowable Roth IRA contribution limit: $5,000 or $6,000 if you’re 50 or older.
Once you’ve made your nondeductible IRA contribution, you may immediately implement step two. Given the fact that, beginning in 2010, there are no income limitations in connection with converting traditional IRA accounts to Roth IRA accounts, step two is to complete your financial institution’s Roth IRA conversion form requesting transfer of the amount that you just contributed to your traditional IRA to your Roth IRA account. Once again, this will be a partial conversion since you generally want to leave funds in your traditional IRA account in order to keep it open for potential future contributions.
Although you have until April 15th to make an IRA contribution for the preceding year, it’s a good idea to execute this two-step process at the beginning of each year assuming that funds are available. This will get you in the habit of making sure that you implement this strategy each year, and, if done consistently over a number of years, can substantially add to the value of your Roth IRA account.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.