Non-Deductible IRA Contribution Roth Conversion
I have a client whose salary exceed the limits for Roth IRA Contributions. Can she contribute to a Non-Deductible Traditional IRA and immediately convert to a Roth IRA? She has other Traditional IRA’s and a 401k that she would not be converting. Should we keep the Non-Deductible Traditional IRA in a separate account to alleviate tax issues the the other Traditional IRA’s that won’t be converted?
Permalink Submitted by Alan Spross on Tue, 2010-10-26 23:24
The non deductible contribution can be made and the account converted, but the pro rate rules apply over all TIRA, SEP IRA and SIMPLE IRA accounts. Because she has other TIRAs, the conversion would be mostly taxable. The only way to avoid that is to transfer the entire pre tax IRA balance into an employer plan that will accept IRA rollovers. That would leave only the after tax balance in the TIRA and the conversion would then be tax free.
The 401k does not affect the IRA formula, and if the 401is directly converted, the taxable percentage would be based solely on the amount of after tax vrs pre tax amounts in the particular 401k.
This strategy is widely touted in the financial press, but they often fail to mention that the conversion is tax free ONLY if the client had no TIRA account before making the non deductible contribution. Of course, this is still an effective way to get funds into a Roth IRA even if taxes are due on the conversion.
Permalink Submitted by [email protected] on Mon, 2010-11-22 18:45
On the NAPFA forum, someone was in a tax conference where both former and current IRS appeals officers were attending and presenting. One of the topics was the Roth Conversion issue. The IRS personnel said they would deem a non-deductible IRA contribution that is “converted” to a Roth in the same tax year as a Roth Contribution. The recommendation was to make the non-deductible contribution in one tax year and convert in another. What is your understanding of the risk in converting in the same tax year as making the nondeductible contribution?
Thanks
Carol
Permalink Submitted by Alan Spross on Mon, 2010-11-22 19:34
I don’t think there is any risk in doing the conversion immediately after the contribution as long as the tax code remains as it is. But I do understand that there may be some frustration with the ease in which the “work around” to the Roth regular contribution income limits can be executed. That could result in Congress passing legislation to restrict non deductible TIRA contributions in some way or simply to lift the Roth income limits to eliminate the need for a double transaction to get regular IRA contributions into a Roth. If a taxpayer is allowed to convert unlimited amounts without an income limit, there is not much consistency to having income limits for the relatively small regular Roth contribution dollar limits.
The proposed solution to defer conversions to the next year would not solve this problem. Taxpayers could still make contributions and convert them later on, but perhaps the contributions would generate some earnings by the conversion date. But for now, before this loophole is closed, those that are in a position to take advantage should not hesitate.