IRA and 2010 Roth IRA conversion

[Osprey]

I make too much to qualify for a Roth IRA or tax deductible regular IRA contributions. I still want to open an regular IRA for the tax shielded growth that they offer. I am maxing my 401K at work.

I have a couple of questions about the 2010 supposed Roth IRA conversion possibility-

1) Is it worth converting to a Roth?

2) If I can't deduct my contributions to the regular IRA on my taxes, what will I pay taxes on if I convert to Roth in 2010, just the growth, interest and capital gains?

3) Can I roll my 401K into the Roth in 2010?

[spider]

[ QUOTE ]
1) Is it worth converting to a Roth?

[/ QUOTE ]

This pretty much has the same pros/cons of converting a traditional IRA to a Roth. (i.e. marginal tax rate you face now vs after you retire.)

[ QUOTE ]
2) If I can't deduct my contributions to the regular IRA on my taxes, what will I pay taxes on if I convert to Roth in 2010, just the growth, interest and capital gains?

[/ QUOTE ]

You aren't double taxed. You only pay on the earnings, similar to capital gains taxation basically.

But note that it can get complicated if you already have another traditional IRA since you have to do this pro-rating of the basis. I can't explain it very well, but take a look at form 8606 or do some web searching. But if you don't have any other traditional IRAs already set up, it's pretty simple and just walking quickly through the 8606 should make things clear.

[Osprey]

But if I am paying taxes on my contributions anyway, it seems like for 25 years of tax free growth with tax free withdrawals, paying tax on capital gains and dividends only in 2010 would be worth it to almost anyone who is still going to be paying income tax when they are retired.

[spider]

[ QUOTE ]
But if I am paying taxes on my contributions anyway, it seems like for 25 years of tax free growth with tax free withdrawals, paying tax on capital gains and dividends only in 2010 would be worth it to almost anyone who is still going to be paying income tax when they are retired.

[/ QUOTE ]

Yeah, I'm thinking about it some more, and I think you definitely want to do the conversion in 2010. Let me just give an example, and any corrections are of course welcome.

So this year, you put 4k in a non-deductibel IRA and by 2010 it has increased by 1k, to 5k total. You then convert it to a Roth, and pay tax on the 1k.

Now fast forward to retirment and let's say you have doubled the 5k to 10k. Since it is a Roth, you don't pay any additional taxes. If you hadn't converted to a Roth, you would have to pay tax on (1) the the original 1k plus the additional 1k it generated, and (2) the 4k earned on the 4k, but not the original 4k, since that is your basis. The first part here is nothing more than the Roth/traditional issue of pay tax now vs later, but the second part is sort of a free lunch from doing the conversion in 2010.

That's my understanding, corrections welcome, of course. Damn, this stuff just seems so much more complicated than it needs to be...

Also, I think that once you do the conversion to a Roth in 2010 this makes your life simpler b/c the annual calculation of basis in your IRA is kind of a pain. And also, I believe after the conversion you can then withdraw the converted amount anytime, without penalty, just like an ordinary Roth contribution.

[prohornblower]

[ QUOTE ]
But if I am paying taxes on my contributions anyway, it seems like for 25 years of tax free growth with tax free withdrawals, paying tax on capital gains and dividends only in 2010 would be worth it to almost anyone who is still going to be paying income tax when they are retired.

[/ QUOTE ]

It is definitely worth it. The big question is...do you have a giant chunk of money to pay taxes in that year? If so, you should definitely do it.

My friend just left work with like $17K in his 401(k). He's 29, and just converted it this year to a Roth. He will have to pay..I'm guessing...3-4K in taxes next year. Ouch. Still well worth it, though.

[Osprey]

Tax bill shouldn't be that much because I won't have to pay taxes on the contribution, just the growth while in tax deferred state.

[DespotInExile]

[ QUOTE ]
But note that it can get complicated if you already have another traditional IRA since you have to do this pro-rating of the basis. I can't explain it very well, but take a look at form 8606 or do some web searching.

[/ QUOTE ]

Dont ignore this point. Johnathan Clements in the WSJ last week wrote an article about this. See here: http://online.wsj.com/article/SB11750371...ON=wsjie/6month (subscription required)

Net net, you can do the rollover, but it can require some planning, like taking existing conduit IRAs, and rolling them into your participating 401k during your conversion year.

[yellowbastard]

This is a little off topic but is it possible to roll a 401k into a Roth IRA?

[prohornblower]

[ QUOTE ]
This is a little off topic but is it possible to roll a 401k into a Roth IRA?

[/ QUOTE ]

When you leave a job, you typically have 60 days to declare what to do with your 401(k). Typically, people do a rollover to a Traditional IRA. It is similar to the 401(k), in that it is tax-deferred.

From there, you can convert it to a Roth at any time (at which point you will pay taxes on the amount the following April). You can only convert it to a Roth IF you do not meet the maximum Adjusted Gross Income amount.

[yellowbastard]

[ QUOTE ]
When you leave a job, you typically have 60 days to declare what to do with your 401(k). Typically, people do a rollover to a Traditional IRA. It is similar to the 401(k), in that it is tax-deferred.

From there, you can convert it to a Roth at any time (at which point you will pay taxes on the amount the following April). You can only convert it to a Roth IF you do not meet the maximum Adjusted Gross Income amount.

[/ QUOTE ]

Assume a person rolls a 401k into a traditional IRA then converts to a roth IRA. I'm assuming taxes would be due on just the investment income when the person converts from the traditional to the Roth, right? As you mentioned they must also be below the MAGI requirement.

If this is true I think it would only make since for people to rollover and convert (401k -> traditional IRA -> roth IRA) if they had earned very little investment income in the original 401k which is not the case for most retired workers, or many others in need of a rollover.