Roth IRA limits may be lifted

Tax bill alters rules for high-income earners


Individuals shut out of the Roth IRA because of their high income could participate in the popular tax-free retirement account under the federal tax-cut plan facing Congress, financial experts said.

The legislation eliminates income limits for those converting a traditional individual retirement account to a Roth beginning in 2010. Currently, singles and married joint filers with adjusted gross income of up to $100,000 can convert one IRA to another.

The change means that high-income individuals could open a traditional, nondeductible IRA - which has no income limits for eligibility - and then turn around and convert it to a Roth.

"For people who have always wanted a Roth IRA ... this is a backdoor way, and the backdoor is pretty wide open," said Richard O'Donnell, tax editor at RIA, a provider of tax information in New York.

The move is likely to appeal to younger workers who aren't eligible for a Roth now but expect to be in a higher tax bracket in retirement, tax experts say. Roth conversions also could be attractive for estate planning since it would reduce taxes for heirs.

Tax experts say Congress proposed eliminating the $100,000 conversion cap to raise revenue and offset the cost of the $70 billion tax-cut package. When investors convert from a traditional IRA to a Roth, they will have to pay any regular income tax due.

The House passed the measure yesterday by a 244-85 vote; the Senate is expected to clear the bill today.

Critics say the conversion measure would raise revenue in the short term but leave the country's finances worse off later when those tax dollars are sorely needed.

"It's considered a budget gimmick," said Diane Lim Rogers, research director of budgeting for national priorities at the Brookings Institution in Washington.

But some believe Roth conversions will be popular with many investors.

"This IRA conversion is the best of all possibilities. It's a tax increase that everybody loves," said Clint Stretch, a principal with Deloitte Tax in Washington. "It allows you to pay the tax now and get a big benefit later."

The tax-friendly Roth was created in the late 1990s, but contributions are limited by income.

Full or partial contributions to a Roth can be made by singles with adjusted gross income of less than $110,000 and married, joint filers with income of under $160,000. Contribution income limits would not change under the legislation.

Money goes into the Roth after taxes have been paid on it. The maximum annual contribution to IRAs this year is $4,000 plus an additional $1,000 in catch-up contributions for those 50 and older.

But the investments in the Roth grow tax-sheltered, and withdrawals in retirement are tax-free. And unlike the traditional IRA, there is no requirement to take distributions after age 70 1/2 , so the money can continue to grow if the investor doesn't need it.

With a traditional IRA, investors pay ordinary income tax on all or part of their withdrawals in retirement, depending on whether they deducted contributions upfront on their tax returns.

Under the legislation, the conversion cap would disappear in 2010. Taxpayers who convert to a Roth that year could spread the income tax bite over two years, in 2011 and 2012. Anyone making a Roth conversion after 2010 would have to pay the tax bill at once.

"If you convert in 2010, you don't have to pay taxes until 2011 and 2012. You can get a free ride," said Ed Slott, an IRA expert in Rockville Centre, N.Y. "They made it so attractive. They must really want people to do it."

Jim Ludwick, a financial planner in Odenton, says he has heard from a few clients hoping Congress would allow the new conversions.

"When most of them hear about it they will be interested," Ludwick said. "And the sooner they can calculate how much the tax consequence will be, it will help them make a decision whether to do it and start saving money" to pay the tax.

Taxpayers would be able to convert all or some of their traditional IRA to a Roth. Whether to do so, depends on a variety of factors.

For instance, a conversion would make sense for those who think they will be in a higher tax bracket in retirement. Considering that tax rates have come down in recent years while the federal deficit has ballooned, many expect rates will be higher in the future.

Conversely, if you are confident that you will be in a lower tax bracket in retirement, it would not be worth paying taxes at a higher rate now to convert to a Roth, experts said.

The conversion is also best for those who can afford to pay the income tax with money outside the IRA. Those under age 59 1/2 who must tap their IRA to pay the tax would be hit with a 10 percent penalty for early withdrawals, making the conversion too expensive, experts said.

Big beneficiaries of converting will be individuals who rolled a sizable 401(k) into a traditional IRA, and can afford to pay the tax bill upfront, O'Donnell said.

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