Does nondeductible IRA make sense?
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 Dear
Tax Talk,
I am over the income limit for contributing to a Roth IRA and I have a pension plan at work. Does it make any sense to do a nondeductible IRA?
-- Mitch
Dear Mitch,
A Roth IRA contribution is subject to an income limitation whether
or not you have a pension plan at work.
If you're married, your AGI with certain adjustments
has to be less than $150,000 to contribute the full $4,000 to a
Roth; for singles and heads of households, your AGI should be less
than $95,000. A Roth IRA contribution is not tax-deductible. A contribution
to a traditional IRA is not deductible if you have high income and
a pension plan at work. The difference between a nondeductible IRA
and a Roth IRA is that the earnings in a Roth are never taxed. The
earnings on a nondeductible IRA will be taxed as ordinary income
whereas they could be taxed at lower capital gains rates if kept
out of an IRA. Hence most people prefer not to make nondeductible
IRAs.
You can convert amounts in a traditional IRA to a
Roth IRA and pay tax on the earnings currently, but only if your
AGI is below $100,000. However, beginning in 2010, the AGI limitation
for conversions is eliminated. Also, you will have two years to
pay the tax on any amounts converted in 2010. If you make contributions
to a nondeductible IRA in 2006 through 2010 and convert in 2010,
you can roll over $20,000 plus the earnings into a Roth in that
year. If the account earns 6 percent a year, you'll have around
$2,500 in earnings to pay tax on in 2011 and 2012. At a 35 percent
tax rate, this translates into $437.50 in tax per year. With the
law change in mind, it may make sense to do a nondeductible IRA
now.
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