Tax Breaks

Tax-Free Income for All

High-income earners can take the backdoor route to a Roth IRA.

High-income households have always been shut out of Roth IRAs. But a recent change in the tax law lets you get into a Roth -- and enjoy the benefits of tax-free retirement income -- through the back door.

Under current law, you can't contribute to a Roth if you are single and have an income of more than $110,000, or married with a joint income in excess of $160,000. The new law, which goes into effect in 2010, does not alter the income limits for Roth IRA contributions. But it does eliminate the $100,000 income limit for converting a traditional IRA to a Roth. You must pay income taxes at your top rate on the total amount you convert to a Roth -- that's the price you pay to make all withdrawals tax-free in retirement. To encourage conversions, which will bolster U.S. Treasury coffers in the short run and save you loads on taxes over time, Congress says that folks who convert in 2010 can spread the tab over 2011 and 2012.

By opening the back door to Roth conversions for everyone, Congress effectively wiped out the limit on pay-ins, too. And high-income taxpayers can waltz through the door right away. Starting in 2006, you can contribute $4,000 a year to a nondeductible traditional IRA, or $5,000 if you are 50 or older. (The limits rise to $5,000 and $6,000 in 2008.) In January 2010, when the income limits disappear, you can convert the traditional IRA to a Roth IRA and owe tax only on the earnings.

Let's say you're over 50 and stash $28,000 in a nondeductible IRA during the next five years. Let's further assume your account is worth $32,000 by 2010. When you convert that IRA to a Roth, you'd owe taxes only on the $4,000 in earnings. So the price of admission to the Roth would be just $1,120, assuming you're in the 28% tax bracket. You'd pay half the bill in 2012, when you file your 2011 return, and the rest in 2013. If you're married, both you and your spouse could use this strategy to create substantial Roths, even if one spouse does not have any earned income.

In addition to providing tax-free income in retirement, Roth IRAs are a valuable estate-planning tool. Unlike traditional IRAs, which require you to start withdrawals at 70#189;, Roths have no mandatory distribution age. And your heirs can inherit a Roth tax-free.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
You Can Appeal a Medicare Premium Surcharge
Medicare

You Can Appeal a Medicare Premium Surcharge

If you meet one of the seven qualifying life events, you have a good chance of getting a higher premium for Medicare Part B and Part D reduced.
June 16, 2021
12 Housing Stocks to Ride the Red-Hot Market
investing

12 Housing Stocks to Ride the Red-Hot Market

The U.S. has a housing shortage and a love affair with home improvement, both of which could create tailwinds for this group of housing stocks.
June 8, 2021

Recommended

10 States With the Lowest Gas Taxes
taxes

10 States With the Lowest Gas Taxes

Saving money is a marathon not a sprint. And even low gas taxes can help keep money in your pocket.
June 21, 2021
14 States That Won't Tax Your Pension
Tax Breaks

14 States That Won't Tax Your Pension

Some states have pension exclusions with limitations based on age and/or income. But these states don't tax pension income at all, no matter how old y…
June 19, 2021
2021 Child Tax Credit Calculator
Tax Breaks

2021 Child Tax Credit Calculator

Find out how much money you'll get each month under the child tax credit rules for 2021. Payments will start July 15.
June 18, 2021
Child Tax Credit 2021: Who Gets $3,600? Will I Get Monthly Payments? And Other FAQs
Coronavirus and Your Money

Child Tax Credit 2021: Who Gets $3,600? Will I Get Monthly Payments? And Other FAQs

People have lots of questions about the $3,000 or $3,600 child tax credit and the advance payments that the IRS will send to most families in 2021 – a…
June 18, 2021