clarification of conversion
I have a client for whom a Roth conversion makes sense. Client is a doctor and his spouse. The spouse has an IRA and a Roth IRA. We are going to convert the IRA to a Roth and combine them. The wife is a non-working spouse. We then want to fund an IRA in the spouse’s name for $5,000 for this year. Given household income levels, this will all be non-deductible. If we then roll this to the Roth for this year, am I correct in presuming that only thing taxable will be the original (first) conversion of the IRA to a Roth?
Thanks in advance for all help!
Alan
Permalink Submitted by Alan Spross on Thu, 2010-02-04 03:53
No. The tax impact of multiple conversions results in the same % of each conversion being taxable, not different percentages for conversions done on different dates. The taxable portion is based on the year end portion of the total adjusted TIRA value (with conversions added back in) that is represented by the pre tax amount.
I would suggest first making the 2009 TIRA contribution if this has not yet been done ALONG with the 2010 contribution. Then convert the entire TIRA balance to a new Roth IRA unless the amounts are small enough, and she can just convert into the existing Roth. This will reduce the conversions to one only. An 8606 added to the 2009 return would report the 2009 non deductible contribution. For 2010, an 8606 would also report the 2010 non deductible contribution and also the amount of the conversion that is taxable, but ONLY if she opts out of the special two year tax deferral on 2010 conversions. If 2009 has already been dealt with, forget about the 2009 portion.
SInce 2010 conversions will normally be included in income in 2011 and 2012, the actual taxable portion would not be determined until the end of those respective years on an 8606 for those respective years. If she opts out of the deferral, then the entire conversion is reported in 2010 using 2010 year end values as indicated above. Their overall tax situation and bracket for the various years would determine whether to opt out of the deferral or not. These spousal IRA accounts probably are only a very small portion of their joint income unless she has a large rollover IRA.
Permalink Submitted by Alan Myers on Thu, 2010-02-04 05:45
Thanks for the information. She does not have a large rollover at all, so that’s immaterial. If, at the end of the year, the spouse has no IRA left (or one with a zero balance… our custodian can keep it open so we can fund it again next year and convert if we want to…), then this should simplify the calculations, shouldn’t it? The taxable portion will only be the amount currently in the traditional IRA (less any basis, but since it’s a rollover, there is no basis there). The intent is to not have a balance in the TIRA at year-end so, if I am reading your response and Mr. Slott’s article in Investment News correctly, then this calculation remains simple. If we have a balance in a traditional at year-end, then we’re back to filling out the 8606 to determine the taxable amount…. (I know… I know… we’ll fill out the 8606 anyway but if the balance is zero in the TIRA at year-end, then only the amount that was originally in the TIRA is taxable).
Have I got it right? Thanks again!
Alan
Permalink Submitted by Alan Spross on Thu, 2010-02-04 06:04
If all the current TIRA balance is converted during the year such that there is no year end balance, all the existing basis will be applied to the conversions. Some IRA custodians will allow the same account number to remain open, others may not. However, this really makes no difference and has no affect on tax issues.
An 8606 is still required to report the conversion even if there is no balance left. The year end balance is just entered as -0-.
If there are to be no incoming rollovers, a cycle can begin where a non deductible contribution is made every year and immediately converted. Since there is no other balance, this conversion will be tax free. The net affect is the same as if the high income taxpayer was able to make a regular Roth contribution, so this gets the taxpayer around the income limits for regular Roth contributions.
If both spouses have IRAs, it is generally best to convert the one with the highest % of basis in it because it gets more dollars into a Roth IRA for the least amount of conversion tax.