Learn the rules. Roth retirement IRAs offer tax-free earnings. While contributions can’t be deducted, earnings are tax-exempt if used during retirement. With years to compound, Roth contributions can generate big savings. But high earners (singles earning at least $114,000; couples, at least $166,000) can’t contribute to Roths, and they’re usually ineligible as well to contribute to tax-deductible IRAs. High earners can contribute after-tax money to nondeductible IRAs, where earnings are taxed at withdrawal. In 2010 a little-noticed tax provision allows high earners to convert those IRAs into Roths. It’s a back door into these rewarding accounts.
Start building. Contribute the maximum to a taxable IRA now so you can move that money later. You can contribute up to $4,000 each for yourself and your spouse for 2007 (until April 15, 2008), and up to $5,000 each in 2008. Folks older than 50 can add an extra $1,000 to each year’s contribution. By 2010 they could salt away $46,000.
Make the move. In 2010 convert the taxable IRA to a Roth IRA. Income taxes will be due on the earnings the account has amassed, but then you’re home free: the Roth compounds tax-free. Invested, say, at 8 percent for 25 years, that initial $46,000 contribution could grow into a tax-free pot of $371,000. Left in the traditional IRA, all but the initial $46,000 would be taxable as it was withdrawn. The strategy is less sweet if you’ve already got a big tax-deductible IRA from earlier days. There are ways around that, but they’re complex enough to be best left to a tax pro. Yes, lots of rules, lots of math. But at the end of the day, lots more money, too.
