Income too high – Open a non-deductible then convert?
Ed was quoted saying to open ND IRA’s and then immediately convert them to Roth since there would be no significant gain and thus no tax. However, what if both of us already have a ND IRA? Would the conversions have to be pro-rated across that other ND IRA and how is that calculated, especially if it contains both deductible and non-deductible contributions?
Would another option be to open a new ND IRA, back the money out of the one I mentioned and put it in the newer one thus keeping it “pure” and easier to convert? Does this violate some tax rule? We both already put our max. contributions in for this year, but would like to convert thse dollars to a roth.
Permalink Submitted by Alan Spross on Fri, 2010-12-03 02:11
The non deductible contribution followed by a tax free conversion is only possible if you do not have other IRA accounts. Since the basis from non deductible contributions must be spread over all TIRA, SEP, and SIMPLE IRA accounts, there is no re alignment possible within your IRAs to be able to convert more basis. If you have a large rollover IRA from an employer plan, it will result in a particularly high % of the converted amount being taxable.
However, there is one possible solution. If your current employer plan accepts IRA rollovers, you can transfer the pre tax amount into the employer plan, leaving only the basis behind in the IRA. From there you can convert tax free.
All these calculation are generated on Form 8606, which is used to report non deductible contributions and also to report conversions.
Permalink Submitted by Mike Hunt on Fri, 2010-12-03 16:57
By “employer plan,” are you referring to a 401k or 403b that I might have currently through my employer?
Permalink Submitted by Alan Spross on Fri, 2010-12-03 16:59
Yes. Either would work, but the chances are better that a 401k would accept rollovers than a 403b. And some plans that will accept an IRA rollover limit them to conduit or rollover IRA accounts only.
Permalink Submitted by Mike Hunt on Fri, 2010-12-03 17:48
You say “pre-tax.” If I have already contributed my $6ooo (over 50) to my existing non-deductibe IRA for 2010…I’m confused again, as these are post-tax dollars.
Or, is what you are recommending is moving the dollars I have already paid taxes on (that are mixed into that same IRA) over into the 401K?
Permalink Submitted by Alan Spross on Fri, 2010-12-03 18:02
Since your after tax (non deductible contributions) basis is spread across all your IRA accounts, this is a dollar amount, and all your IRA values in excess of that amount are pre tax regardless of which account they are in. Consider all your IRAs as one large combined IRA.
An employer plan is forbidden to accept any after tax dollars from IRAs. While you would endeavor to transfer the entire value in excess of your basis into the employer plan, the plan might not accept ANY balance from an IRA account that you have made regular contributions to, but would accept a rollover IRA if you have one. In that case, you could roll the rollover IRA into the plan but would be left with your other IRA accounts. If those remaining accounts are worth 30,000 but you have made 3 non deductible contributions of 6k each, then your basis is 18k. If you converted this remaining account, 12,000 would be taxable and the 18k portion tax free.
Sometimes the definition of pre tax or after tax is confusing. You should refer to the funds based on the tax status at present, NOT when distributed. For example, if you make a deductible contribution, those are pre tax funds or if you make a non deductible contribution, those are after tax funds. Earnings are always pre tax. When you take the money out, the pre tax funds are taxed and the after tax funds are not. So it helps to keep this straight by thinking in terms of the tax status while IN THE IRA, not what the tax consequence will be after distribution.