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Nondeductible IRAs: Feather your retirement nest egg

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in Small Business Tax,Small Business Tax Deduction Strategies

Once you’re into middle age, you should start socking away as much for retirement as you possibly can.

Strategy: Max out on nondeductible IRA contributions now, and plan ahead to convert to a tax-favorable Roth IRA in a few years, thanks to the new tax law.

In the meantime, your nondeductible IRA contributions will grow on a tax-deferred basis.

You’ll pay no tax on the accumulation inside the IRA until you withdraw funds.

Here’s the whole story: Until President Bush signed the Tax Increase Prevention and Reconciliation Act in May, Roth IRAs were off-limits to you if your modified adjusted gross income (AGI) exceeded $110,000 for unmarried filers; $160,000 for joint filers.

But beginning in 2010, you’ll be able to convert to a Roth IRA—from which your qualified distributions are tax-free, versus paying ordinary-income tax rates (up to 35 percent) for traditional IRA distributions— regardless of your AGI.

The new law removes the income limitation for tax years beginning after 2009.

To sweeten the deal, the new law also allows you to defer the resulting tax on the conversion and spread it over the following two years—2011 and 2012—if you elect to convert to a Roth IRA in 2010.

In the meantime, you can start socking away up to $5,000 in a traditional IRA (maximum $4,000 contribution in 2006, plus a $1,000 “catch-up” contribution if you’re age 50 or older).

After 2007, the maximum contribution allowed will rise to $5,000, plus the $1,000 catch-up. After 2008, the maximum contributions will be adjusted for inflation in $500 increments.

Tip: You can’t deduct traditional IRA contributions if you participate in an employer-sponsored plan and your AGI exceeds an annual threshold. (For 2006, the limit is $60,000 for unmarried filers; $85,000 for joint filers).

Thus, if you don’t participate in a tax-favored company retirement plan, you may qualify for deductions no matter how high your income is.

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