IRA 'window' can be golden opportunity

Back in April, I passed along some advice that drew two very different responses.

The reader involved, Daniel, is a 28-year-old single man who makes more than $160,000 per year and is actively saving for retirement. He wrote in seeking more savings tips.

I wrote at the time that I thought his appearance in my column would draw interest from single women, and it did (more on that later).

But part of the column that dealt with individual retirement accounts drew a different kind of response.

In the original column, I sought guidance from Roger Smedley and Sharla Jessop of Salt Lake-based Smedley Financial Services. Sharla said a non-deductible IRA might be a good choice for Daniel, as his income is too high for him to invest in a traditional or Roth IRA. She said that, in 2010, Daniel could take advantage of a legal window of opportunity to convert a non-deductible IRA to a Roth IRA and only pay taxes on its growth.

That drew a response from a reader named Kyle.

"Could you provide a greater explanation of this tax provision?" he asked. "Where is it found in the code? What will the tax rate be for the growth on the IRA? Once converted, will contributions to the Roth IRA still be deductible? I'm interested in setting up an IRA and then converting it over to a Roth using this window."

For help with Kyle's questions, I once again turned to Sharla.

She said that, assuming Kyle's income is over $160,000 and he is thus ineligible to set up a Roth IRA, this conversion opportunity could be for him.

The window is a result of the Tax Increase Prevention and Reconciliation Act of 2005, which was enacted by Congress in May 2006, Sharla says. That act changed the rules governing the conversion of traditional IRAs to Roth IRAs. It said that, in 2010, Roth IRA conversions will be available to all taxpayers, regardless of income.

"Right now, if your modified adjusted gross income is over $100,000, you can't convert from a traditional IRA to a Roth IRA," Sharla says. "This window of opportunity ... allows people to put money into traditional IRAs and then convert in 2010 without a modified adjusted gross income limit. It also allows them to spread the tax they have to pay when they convert over two years."

For someone who cannot contribute to a traditional IRA, Sharla again suggests starting a non-deductible IRA. Make the maximum annual contribution, which is $4,000 if you're under 50 and $5,000 if you're over 50. In 2010, convert it to a Roth IRA, and you'll only pay tax on the earnings for that three-year period, because you already paid taxes on your base.