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IRA article, what does it mean for me/us?

Discussion in 'Finance and Investment' started by Ulquiorra, May 10, 2007.

  1. Ulquiorra

    Ulquiorra 2+ Year Member

    Apr 13, 2007
    In a few months I will be a PGY-1 and finally making money. As such, I've been reading up a lot on finance and investment. I started here actually, and from what I have gleaned, I should definitely max out a roth IRA first. Scott and White Hospital offers an optional 403b to which they unfortunately do not match contributions. I was going to put as much into that as I could (it has an annual limit of $15,000). Now I stumbled upon this article (see below), and had a hard time understanding how it would apply to folks like me (new residents), if at all.

    Does it apply to us? And in light of this information, should I plan to do anything differently? Thanks in advance.


    Don't Qualify for a Roth IRA?
    Try Slipping in the Back Door
    March 28, 2007; Page D1

    It's a tortuous journey -- with a happy ending.
    Yes, you should make a 2006 contribution to an individual retirement account by the April 17 tax-filing deadline, even if you don't qualify for the tax deduction. But if your goal is to convert the account to a Roth IRA in 2010, when high-income earners become eligible, you could be in for a nasty surprise. There's a little-known problem with the strategy -- but also two little-publicized solutions.

    Freedom's price. Funding a tax-deductible IRA will garner you an immediate tax break, but withdrawals are taxed as ordinary income. A Roth doesn't offer an initial tax deduction, but withdrawals are tax-free.
    Both accounts can be a great investment. But unfortunately, you won't qualify for either if you're covered by a retirement plan at work and your total income for the 2006 tax year is above $110,000 if you are single, or above $160,000 if you are married filing jointly.

    That still leaves the nondeductible IRA, which has emerged as an intriguing alternative. Before the May 2006 tax law, you could convert a regular IRA to a Roth only if your total income was below $100,000. But last year's tax law removed that income criterion starting in 2010 -- and suddenly nondeductible IRAs became a hot ticket.

    The strategy: Make nondeductible IRA contributions, which in 2006 and 2007 are capped at $4,000 or, if you are age 50 or older, at $5,000. Then, in 2010, convert the whole account to a Roth.

    Imagine that, at that point, the account was worth $25,000, of which $20,000 was nondeductible contributions. When you convert, you would owe income taxes on the account's $5,000 in investment gains. In return for that modest tax hit, your new Roth IRA would grow tax-free thereafter.
    Pretty sweet? It is -- provided you don't have other IRAs. But suppose that, as of 2010, you also have $100,000 in a regular IRA. You couldn't convert just the $25,000 nondeductible account, says James Lange, author of "Retire Secure."

    Rather, you have to assume the $25,000 conversion is coming pro rata from your $125,000 total IRA. Result: You would owe taxes on $21,000 because, in this example, the pro-rata share of your nondeductible contributions would be just $4,000.

    Dodging trouble. Fortunately, there are two solutions. First, if your current employer allows it, you could roll much of your IRA into your 401(k). That may leave you with just your nondeductible IRA -- and no nasty tax bite in 2010, Mr. Lange says.

    Second, even if you have a large IRA, your spouse may not. That means

    your spouse could fund a nondeductible IRA between now and 2010 and then convert his or her account, says Cincinnati financial planner David Foster.

    What if neither solution is an option? What if Congress takes away the 2010 conversion opportunity? Making nondeductible contributions can still make sense. "It's a little bit of administrative work," Mr. Lange concedes. "Other than that, I don't see any downside."

    Without the chance to convert in 2010, a nondeductible IRA might seem unappealing because eventually your withdrawals would be taxed at federal income-tax rates as high as 35%. By contrast, if you invest in a taxable account, you can take advantage of today's low tax rate on long-term capital gains and qualifying dividends, which currently tops out at 15%.
    But the IRA is still a fine savings vehicle if you plan to buy bonds, real-estate investment trusts and actively managed stock funds. After all, part or all of your gain from these investments will be taxed as ordinary income anyway -- and the IRA allows you to defer those taxes.
    Moreover, if you can't convert in 2010, you may get an opportunity when you retire. One tax-smart strategy: Leave your 401(k) balance with your old employer for a few years and use that time to convert your IRA, including your nondeductible contributions, to a Roth. Because you no longer have a paycheck, you should be in a low tax bracket -- and the cost of converting ought to be pretty modest.
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  3. IceMan0824

    IceMan0824 Holy crip, he's a crapple 5+ Year Member

    Dec 7, 2006
    I remember this article when it came out.
    It reads (to my understanding)

    1. Fund a Roth IRA
    2. If you make too much, $110,000 single, $160,000 married, or have work retirement plan, you might not qualify for the Roth
    3. Instead, open a non-dedcutible IRA, and fund it.
    4. In 2010, when the qualification for the Roth is relaxed for contribution to Roth IRA, convert the non-deductible IRA to a Roth.
    5. Pay tax on the interest gain
    6. Watch out for the "catch"
    7. Gives two ways to get out of the catch
    The rest are just details...

    In short, as a PGY-1, you probably will still qualify for a Roth IRA, then ignore step 2-7. As an attending, you might no longer qualify but if your residency runs longer than 3 yrs, then in 2010, it probably won't matter.

    P.S. I never liked non-deductible IRA, but that's just because of the filing complication that it brings.
  4. etf

    etf Moderator Emeritus 10+ Year Member

    Apr 27, 2005
    this is what i was pretty much talking about in a previous thread - my advice was to max out the 403(b), even if it does not have a match, simply because you can put away more money in it - $14k vs. $4k. then, around 2010, roll over that 403(b) into an ira, and then convert that ira into a roth. obviously you can put the first $4k into a roth (if you qualify) and then put $10k into the 403(b), but it all works out in the end.
  5. The White Coat Investor

    The White Coat Investor AKA ActiveDutyMD Physician Partner Organization 10+ Year Member

    Nov 18, 2002
    SDN Partner
    It's a good idea, the only problem is funding 1-2 Roths (8K this year, 10K next year) and maxing out a 403b (15.5K) on a resident salary. Let's see...25.5 in the bank, that leaves you what....$14K to live on?
  6. Ulquiorra

    Ulquiorra 2+ Year Member

    Apr 13, 2007
    Hahaha, thankfully I'll be living in a city that's not too expensive to live. And on top of that, I lead a fairly simple lifestyle. But we'll see how it goes.

    The cap for the Roth IRA is 8k this year? Sweet!
  7. etf

    etf Moderator Emeritus 10+ Year Member

    Apr 27, 2005's 4000; i don't know where the 8k figure came up.
  8. UserNameNeeded

    UserNameNeeded SOS 7+ Year Member

    Dec 29, 2004
    I think he means 4K for you + 4K for your spouse.
  9. Ulquiorra

    Ulquiorra 2+ Year Member

    Apr 13, 2007
    Haha, I don't think the US government would count my left hand as my spouse.
  10. IceMan0824

    IceMan0824 Holy crip, he's a crapple 5+ Year Member

    Dec 7, 2006
    If your left hand pays its own taxes, you can pass it off as a spouse.

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