retirement

Why a Roth IRA conversion makes tax sense

Don TaylorQuestionDear Retirement Adviser,
This is a good news/bad news situation. It seems that I exceed the income limits for opening a Roth individual retirement account, but I have been considering opening a nondeductible IRA and then rolling it over to a Roth IRA. Can this rollover be done only once, or would I be able to deposit money into a nondeductible IRA and then roll it over into the Roth IRA each year, provided there are no changes in the tax law?
-- Jerry Jump-start

AnswerDear Jerry,
You can do this every year, though it's not a rollover; it's a Roth IRA conversion. To my mind, the requirement that taxpayers have to take this extra step is one of the oddest provisions in the tax code. But then again, I'm not an accountant. I'm sure an accountant could point out stranger provisions in the tax code. The reason for the two-step appears to be so the individual has to consider all his traditional IRA balances when converting some of the balances to a Roth IRA. Individuals can't cherry-pick the nondeductible contributions to a traditional IRA as being the ones being transferred to the Roth IRA, and by doing so, minimize the income tax obligation of the conversion.

Taxpayers with the taxable compensation to do so can make nondeductible contributions into a traditional IRA up to their contribution limits, regardless of their income levels. Taxpayers are limited by adjusted gross income levels as to whether they can contribute directly into a Roth IRA, but there are no income limitations in doing a conversion from a traditional IRA into a Roth IRA.

Retirement investors typically have more control over investment choices and account expenses with a Roth IRA than they do with their company-sponsored retirement plan. A Roth IRA also can provide a measure of tax diversification if the rest of the taxpayer's retirement money is invested in tax-deferred accounts. That's because the Roth investor is front-loading the tax payment, which allows him to take qualified distributions tax-free in retirement.

Once you're past the company match in your firm's 401(k) or 403(b) plan, it's time to at least consider your options in investing nondeductible contributions in a traditional IRA with the thought of converting them to a Roth IRA. Working with a financial planner or tax professional can help you decide if this is the right move for you.

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