Can I open an IRA after tax?

[grasshopper]

I have a 403b at work and want to open an IRA with after tax dollars so that the earnings will grow tax free and so that in 2010 I can convert to a Roth. Can I do this? I can't seem to find the information online anywhere. I know that people who exceed the income limits can, but I'm not sure about the 403b info. Any help would be appreciated.

[The Honest Dollar]

Yes, you can do this. Simply open a traditional IRA (a non-Roth IRA) and DON'T deduct this on your tax return. I am assuming since you mentioned that you have a 403(b) that you do not meet the income requirement for deducting an IRA. Then, in 2010, you can convert to a Roth.

However, if you have an existing IRA which you deducted from your taxes the year you opened it, then you will need to pay some taxes on the conversion in 2010. This is because you can't specify to the IRS in 2010 that you want to convert just the $5,000 (or whatever amount) you put into a non-deductible traditional IRA. The IRS will look at your total IRA balance as a pool of money, and make you pay taxes on the proportion of your conversion that was deductible.

So an example. Say you contributed $12,000 to your IRA in previous years, and you took the tax deductions in those years. This year, you put $4,000 into a non-deductible traditional IRA. Then, in 2010, say you want to convert $4,000 to a Roth. Then the IRS will tax you as follows: you have $16,000 total in your IRA. $12,000 was deducted, and $4,000 was not. Thus, 75% of your IRA balance is subject to taxes when you convert to a Roth. So when you convert just $4,000, the IRA will tax you on $3,000 (75%) of your conversion.

This might not have been entirely clear. Feel free to ask more questions!

[The Honest Dollar]

By the way, if you are looking for specific income limits on deductibility, read IRS Publication 590.

I believe the applicable passage is:

For 2007, if you were covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your modified AGI is:

• More than $83,000 but less than $103,000 for a married couple filing a joint return or a qualifying widow(er),
• More than $52,000 but less than $62,000 for a single individual or head of household, or
• Less than $10,000 for a married individual filing a separate return.

For 2007, if you either lived with your spouse or file a joint return, and your spouse was covered by a retirement plan at work, but you were not, your deduction is phased out if your modified AGI is more than $156,000 but less than $166,000. If your modified AGI is $166,000 or more, you cannot take a deduction for contributions to a traditional IRA.

And:

For 2008, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your modified ad-
justed gross income (AGI) is:

• More than $85,000 but less than $105,000 for a married couple filing a joint return or a qualifying widow(er),
• More than $53,000 but less than $63,000 for a single individual or head of household, or
• Less than $10,000 for a married individual filing a separate return.

If you either live with your spouse or file a joint return, and your spouse is covered by a retirement plan at work, but you are not, your deduction is phased out if your AGI is more than $159,000 but less than $169,000. If your AGI is $169,000 or more, you cannot take a deduction for contributions to a traditional IRA.

[grasshopper]

Thanks much! I do (fortunately or unfortunately depending on how you look at it - I'll say fortunately) exceed the income limits to deduct more money for an IRA. I still think it is advantageous for me to contribute for the reasons listed above. I really appreciate it!

[The Honest Dollar]

Originally Posted by grasshopper

Thanks much! I do (fortunately or unfortunately depending on how you look at it - I'll say fortunately) exceed the income limits to deduct more money for an IRA. I still think it is advantageous for me to contribute for the reasons listed above. I really appreciate it!

Ah, we're in the same boat. I'll be converting my non-deductible IRAs in 2010 as well. Hopefully it won't be too complicated; I do have $3,000 in a deductible IRA, but if I convert the whole thing in one shot (fingers crossed that I can cover the tax liability) I won't have to worry about it after that.

[Mark P. Cussen]

If you're going to open a non-deductible, after-tax IRA, then you need to open a Roth IRA, as long as your income is not above the contribution threshold. There is absolutely no reason not to, given your stated objective.

Mark P. Cussen, CFP, CMFC

[rstlne]

Just wondering but why couldn't you open a Roth IRA right now? That's assuming of course that you're under the income limit for Roth IRA contributions. If you're over the limit then it makes sense to contribute to a non-deductible Traditional IRA now and then convert to Roth in 2010.

[grasshopper]

Original poster here. I do make too much money to contribute to a Roth IRA and to deduct traditional IRA contributions (because I have a 403(b)). I've opened a traditional IRA for 2007.

Thanks for the info!