2010 Roth IRA Conversion with Losses
I’m considering converting my traditional IRAs to Roth IRA in 2010. Let’s say that there are two seperate traditional IRAs:
1. Pre-tax Rollover IRA ($11,000)
2. Non-deductible traditional IRA (cost basis: $18,000 , current value: $15,000)
My initial thought is to move the Rollover IRA to the current employer’s 401K and only convert the non-deductible traditional IRA to Roth IRA to minimize taxes. Though the current value ($15,000) of the non-deductible traditional IRA is lower than the cost basis ($18,000), I was informed that I would not be able to recognize this $3,000 losses in my tax return (though we do pay taxes with any gains).
Assuming that both traditional IRAs were converted to Roth IRA instead, would I be able to offset the $3,000 losses from the non-deductible IRA toward the $11,000 pre-tax rollover IRA to decrease taxes (i.e. tax on $8,000 instead of $11,000). Any advise would be highly appreciated.
Permalink Submitted by Alan Spross on Thu, 2009-11-12 20:14
If you converted both IRA accounts, ie your entire TIRA balance, you would recognize your basis of 18,000 as shown on your most recent 8606. That would result in the taxable amount for the conversion of $8,000. Your basis is not tied to any particular IRA account, it applies over all your TIRA, SEP or SIMPLE IRA accounts. This means that regardless of which IRA account funded the conversion or how much was converted, 30.77% of the converted amount would be taxable. (.3077 X 26,000 = 8,000).
With respect to your initial plan, if you first roll the 11,000 conduit IRA back to a QRP, you still have 18,000 of basis in your remaining IRA. If you convert that TIRA to a Roth IRA, the conversion would be tax free. However, you have still closed out all your TIRA accounts at this point, and therefore you would qualify for a misc itemized deduction for the $3,000 loss. subject to 2% of AGI floor. Whoever indicated that no deduction was allowable was incorrect. Of course, you must be able to itemize and not be subject to AMT in order to utilize the misc deduction.
Permalink Submitted by Mary-Ann Wong on Thu, 2009-11-12 22:04
Thanks, Alan. You’re reply is very clear.
From the look of it, I’m now leaning toward my initial plan (i.e. of rolling the conduit IRA back to a QRP and convert the remaining TIRA to a Roth IRA). But I have to give this more of a thought. If my IRA losses widen for the remaining year, I may be better off converting the rollover IRA, too.
Permalink Submitted by Alan Spross on Thu, 2009-11-12 23:34
Another option would be to roll 8,000 of the conduit IRA to the QRP. That would leave you with 18,000 in your TIRA which could all be converted tax free. Instead of messing with a limited misc deduction, that 3,000 would be added to your Roth balance.
Before you start the process, be sure that your plan will accept incoming IRA rollovers. Many of them require that the source IRA be registered as a “rollover IRA” and will not accept funds from a contributary IRA because they are afraid of acquiring non deductible contributions. A QRP is not allowed to accept any non deductible contributions under any circumstances.
Permalink Submitted by Mary-Ann Wong on Fri, 2009-11-13 00:11
My conduit IRA is registered as a “Rollover IRA” which is totally separate from my Traditional IRA (all non-deductible contribution) and Roth IRA. I’ve also checked with my employer and the investment firm (Fidelity) managing our 401K and they confirmed that they would accept a rollover IRA.
I didn’t realize I can do a partial rollover of my conduit IRA. This option may be better. I’ll have to confirm with the investment firm (Vanguard) holding my conduit IRA if they could accomodate a partial rollover.
Thank you very much for your assistance on this topic. There are so much to learn.
Permalink Submitted by Alan Spross on Fri, 2009-11-13 01:04
If they tell you that a partial account rollover is unacceptable, you can partition the rollover IRA into two accounts first by same trustee transfer. Then you can roll the entire balance of the $8,000 account to the 401k. The remaining $3,000 portion would then be converted along with the other IRA account when you do the conversion.
Permalink Submitted by Mary-Ann Wong on Tue, 2009-11-24 17:50
On a separate issue, am I allowed to convert my non-deductible 2010 traditional IRA contribtion in the same year? I’m thinking of converting my existing Rollover and Traditional IRAs to Roth IRA in 2010 immediately after making my 2010 non-deductible traditional IRA contribution of $5,000. Or should I convert first before making the 2010 contribution? Are there any differences or impications either way?
Permalink Submitted by Alan Spross on Tue, 2009-11-24 17:59
It is more efficient to make the 2010 contribution first and then do the conversion, as that saves the step of a second conversion. However, since you can make as many different conversions as you wish, if you converted the original balance first, then made a contribution later, all you would need to do is make a second conversion for the current regular contribution. The only tax impact of this decision is that the longer time passes for earnings to accumulate in the TIRA, the higher the tax bill will be for the conversions.
Permalink Submitted by Mary-Ann Wong on Tue, 2010-01-19 23:40
Hi Alan,
After so many follow ups with Fidelity and Vanguard with them giving me different instructions, I was able to transfer $8,000 of my rollover IRA to my 401K in preparation of my Roth IRA Conversion.
I am now in the process of converting the remaining traditional IRAs to Roth IRA. Given that the remaining value of my traditional IRAs is roughly equal my cost basis, is there any benefit in creating a separate Roth IRA registration to hold my converted funds in addition to my existing Roth IRA which hold my past contribution?.
Your help is very much appreciated.
Permalink Submitted by Alan Spross on Tue, 2010-01-19 23:52
Since there is no way that you will not be eligible to convert in 2010, and since your conversion will be totally tax free or near so as I understand it, I do not see any need to create a separate Roth account number for your 2010 conversion.
Some people still create separate Roth accounts just to track their various conversions in the event they wish to withdraw them within 5 years. However, a tax free conversion does not incur an early withdrawal penalty EVEN if you withdraw it before 5 years because the penalty would only apply to the taxable amount, which is -0-.
You should still have a way to keep track of your regular and conversion contributions so you will know how to report them if you ever need a distribution before your Roth is qualified. That could be a tally sheet or whatever format you prefer.
Also, since your 2010 conversion will have such a small taxable amount, it will probably be simpler for you to opt out of the two year deferral and just report the small taxable amount of the conversion on your 2010 return. Then you will not have to deal with minute amounts of additional income in 2011 and 2012.
Permalink Submitted by Mary-Ann Wong on Tue, 2010-01-19 23:54
In regards to the 5-year holding period for Roth IRA prior to distribution, is this counted from the time you open your Roth IRA or based on the opening of each investment fund of the Roth IRA account? Does annual contribution re-set your 5-year holding period? I’m a bit confused.
Permalink Submitted by Alan Spross on Wed, 2010-01-20 00:12
There are two totally different Roth 5 year holding periods as follows:
1) To determine when your Roth is qualified for tax free earnings distributions. This is measured from Jan 1 of the year you make your first Roth contribution of any type (regular or conversion). You must also be 59.5 to meet the qualification requirement. The number of actual investments does not matter, just that you made a contribution.
2) To determine if withdrawing specific conversions is subject to the 10% early distribution penalty. Since you are doing a conversion, I assume this is the one you are referring to. Each conversion has it’s own 5 year holding period. That means that conversions done prior to 2006 have met the requirement. Distribution of conversions starts with the oldest first. But if you withdraw so much that you get to your 2010 conversion prior to 2015, it does not matter because this conversion will have no taxable amount to it and there is nothing to apply to penalty to. Also note that this penalty totally stops at age 59.5 because it is an early withdrawal penalty.
Hope this helps.
Permalink Submitted by Mary-Ann Wong on Wed, 2010-01-20 00:19
Thank you for your replies. They are very helpful. From what you have said, I don’t see any major reason in my case to have a separate Roth IRA registration.
Again, thanks.