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Can't put in Roth and it seems wasteful to put it in a traditional after taxes if we can't deduct since it will be taxed again when we take it out. I've heard you can convert the traditional to a Roth. Is this worth it?

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As mhoran_psprep points out, you will not be taxed on the post-tax money that you contribute to a Traditional IRA when you take that money out. You will be taxed on the earnings from that money but only when you take the money out, perhaps many years from now. So, if you are young, you can get many years of tax-deferred earnings on the post-tax contributions you make, which means that they will grow faster than the same amount outside the IRA. If you are close to retirement, the issue is not so clear since it might be better to have capital gains outside an IRA rather than inside the IRA. – Dilip Sarwate Feb 28 '12 at 20:27
This is a great question. I just discovered the phase out for the traditional IRA while preparing my taxes this year and was chagrinned. Thanks for the good question and the good answers! – mehaase Feb 28 '12 at 20:43

Yes, if you don't have any pretax IRA right now, you deposit to the non-deductible IRA, then convert to Roth.

This two-step creates issues for those who DO have pretax IRAs. Say I have $45K in my IRA all pretax, if I deposit $5K non-deductible, and then convert $5K, 90% of that conversion is taxed per the pro-rata rule. (45/50 = 90%).

As I started, if no pretax money, you are golden, just a bit of paperwork. There is no reason not to do it.

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Does this approach circumvent the income phase out for the Roth IRA? This seems like a major loophole, no? – mehaase Feb 28 '12 at 20:46
Yes, that's the point of the two-step, and yes, it's a major loophole. Will they close it? I don't know. – JoeTaxpayer Feb 28 '12 at 22:38

If you put your money into non-deductible IRA you will only be taxed on the profits. The profits are treated as ordinary income from a traditional IRA. If they were in a non-IRA account they would be treated as capital gains.

To convert the non-deductible IRA to a Roth the guidelines can be simple or more complex depending on if you already have traditional IRA accounts. You have to make sure that you take into account the "pro-rata rule" to determine how much is deductible.

As to is it worth it. The befits can not be determined with certainty. The tax law is in flux. Will the the rate of taxes on capital gains be increased, decreased, or eliminated? Will we go with flat tax?

Hard to predict the next 50 years.

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