Nonsensical IRA and Roth IRA Items (Part 2 of 3)

By Jeffery Levine, IRA Technical Expert  
Follow Me on Twitter: @IRAGuru4EdSlott

I think we can all accept that the Tax Code is confusing. After all, it has to provide the rules for an extraordinarily vast array of circumstances. Sometimes though, the Code goes beyond merely confusing and borders on the bizarre. “Why would Congress do that?” you might ask yourself… and you’re not alone. While there are more than just a handful of bizarre items in the Tax Code, we’ve chosen to highlight three of them that relate directly to IRAs.

Below is the second (a day early!). Check back next Wednesday for the final installment.

Roth IRA Conversions vs. Roth IRA Contributions

Beginning January 1, 2010, the income limit and filing status restrictions on Roth conversions were permanently eliminated. The result? Anyone and everyone can now convert unlimited amounts of other retirement funds to Roth IRAs. If you have an IRA, no matter how big or small, no matter how much income you’ve earned during the year, and no matter what your filing status is, you can now convert that IRA to a Roth IRA and have it grow tax-free for the rest of your life.

But while the restrictions for Roth conversions have gone away, the restrictions on Roth contributions have not. In 2011, you can make a maximum Roth IRA contribution of $5,000 ($6,000 if you are 50 or older by the end of the year), but only if your income is under certain levels. If you are single and make more than $122,000 this year, you can make no Roth contribution. If you’re married and file a joint return, you are completely phased out above $179,000.

So let’s play this out for a second… Imagine that you and Bill Gates are best friends. Bill tells you that he is thinking about converting his $5 billion IRA to a Roth because he likes the idea of tax-free future growth. Now imagine that you and your wife work and collectively make 180,000. Between college tuition costs for your two children and paying down a mortgage, you’re just able to afford to save $10,000 per year. You like the idea of tax-free growth as well and would like to use your available $10,000 to make a $5,000 contribution to a Roth IRA for both you and your wife.

So you go to your financial advisor and tell him your plan, except he tells you that you aren’t eligible to make those contributions because your income is too high. Bill’s, whose wealth far exceeds yours and whose income dwarfs yours is just fine converting his $5 billion IRA, but you can’t even contribute a single dollar to yours. Seem fair? Make sense? I didn’t think so.