Jonathan’s Story: Roth IRA

For years, my income was too high to deduct a traditional IRA contribution or fund a Roth IRA, so I was left making nondeductible contributions to a traditional IRA. Meanwhile, before 2010, I couldn’t convert my traditional IRA to a Roth, because my income was above the $100,000 cutoff. But in 2010, the law changed, so that anybody could convert.

I jumped at the opportunity, converting my $111,249 traditional IRA to a Roth. The sweetener: I only had to pay taxes on $62,674 of additional income. Why not more? By then, my traditional IRA contained $48,575 of nondeductible contributions. Those contributions represented dollars that had previously been taxed, so the IRS didn’t expect me to pay income taxes on them again. Result: I now had $111,249 growing tax-free—but, to get that tax-free growth, I only had to make a onetime tax payment of around $20,000.

In subsequent years, I would make my $5,000 annual nondeductible IRA contribution (the maximum is now $5,500, plus an additional $1,000 if you’re 50 or older) and then later convert it to a Roth. That, along with market gains, further fattened my Roth.

For tax purposes, you can’t convert just your nondeductible IRA. As I explained in the previous section, you have to assume that any conversion comes pro-rated from all your IRAs combined. Aware of this rule, I held off rolling my old 401(k) into an IRA, so all I had was a nondeductible IRA.

Now that I have a fairly substantial Roth IRA, my hope is to leave it untouched and bequeath it to my children. Under current law, I’m not obligated to take required minimum distributions from my Roth—and, assuming my kids inherit the account, they would be able to draw it down slowly using the “stretch IRA” strategy. Unfortunately, it increasingly looks like the politicians will kill the stretch strategy and insist that nonspouse beneficiaries empty all IRAs within five years. Even if that happens, my children will receive a pool of income tax–free money, which should make for a handsome inheritance.

Next: Roth’s Five-Year Rule

Previous: Converting Nondeductible IRAs to a Roth

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