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retirement

Back Door to a Roth IRA

There's a way to fund a Roth even if your income exceed the limits for contributing to one.

My wife and I are both maxing out on our contributions to our 401(k)s. With a combined income of more than $200,000, we are not eligible to contribute to a Roth IRA. Is there another tax-deferred retirement-investment option for people in our tax bracket?

Although you earn too much to contribute to a Roth IRA, there is no income limitation on converting a traditional IRA to a Roth IRA.

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Each of you could open a traditional IRA for 2010. You have until April 18, 2011, to contribute to the account -- you may each invest up to $5,000, or $6,000 if you were age 50 or older by the end of 2010. Then you may immediately convert the traditional IRA to a Roth.

If your nondeductible, after-tax contributions represent your only IRA money, your conversion to a Roth IRA is tax-free. The calculation gets trickier if you already have IRA funds (whether in the same account or spread over separate IRAs) that represent tax-deductible contributions. In that case, the tax-free portion of the conversion is based on the ratio of nondeductible contributions to the total balance in all of your traditional IRAs. For example, if your total IRA balance is $100,000 and $20,000 came from nondeductible contributions, then only 20% of any conversion would be tax-free. The rest would be taxed at your regular income-tax rate.

But once the money is in the Roth, you’ll be able to withdraw it tax-free in retirement without being subject to required minimum distributions at age 70½. Your heirs will thank you, too. Any money remaining in your Roth IRA will pass to them income-tax-free.

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