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George Saenz, the Bankrate.com Tax Talk columnist Does nondeductible IRA make sense?

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

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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.

To ask a question on Tax Talk, go to the "Ask the Experts" page and select "taxes" as the topic.

Bankrate.com's corrections policy -- Posted: Feb. 27, 2007
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