Next Year’s Roth IRA Loophole: Get In If You Fit In?

We’ll start with a question: when you retire, do you think you’ll be in a higher tax bracket or a lower tax bracket when you quit your job? Let me explain why this question is important. If you have and regularly contribute to a 401(k) or IRA, you are storing money away pre-tax—which means you get to store away some savings from your gross pay, and then Uncle Sam comes and gets his cut. So you’re earning interest on untaxed money. Then at retirement, whichever tax bracket you ended up in is where you will be taxed as you make withdrawals from your account.

In a Roth IRA/401(k), the government gets his cut first, and then you get to save off of the remainder. But at retirement, you get to take out as much money as you want as often as you want without the money being taxed. So generally, if you expect to be in a higher tax bracket in your last few years of work, the Roth IRA is for you.

The problem, however, is that Roth IRAs are subject a several limits. From Reuters:

Only taxpayers who earn less than $105,000 ($166,000 for joint filers) in 2009 can contribute the maximum amount ($5,000 per person, with a $1,000 additional catch up contribution for folks 50 or older) to a Roth IRA. And only people earning less than $100,000, single or married filing jointly, can convert their traditional IRAs to Roths.

That would probably qualify all but a few of you. However, for you unlucky few who are in the upper echelon, that income limit will disappear next year...for one year. You will have to pay taxes on the rollover however, and depending on the size of the nest egg you’re rolling over, you’ll need a pretty significant cash reserve to cover it. For instance, if you have $40,000 in an IRA and fall in the 25% tax bracket, you’d owe $10,000 to the government to switching. So if you can afford it, go for it!

I won’t spoil anymore for the article (and besides, I’m not there yet). But I think you should give the whole article a read. They include other factors to consider if you think about making the switch.