conversion to Roth from nondeductible IRA
This year I want to make a 2010 Roth contribution before April 18. My income is too high to make a direct contribution to a Roth or deductible contributions to a TIRA. So I am thinking of making a contribution to a nondeductible IRA and then converting that to a Roth. Conversions in 2010 apparently have no income limits. Problem: I went to my credit union to open a nondeductible IRA, but it said they only offer RIRAs and TIRAs, not nondeductible IRAs. I have a feeling I am missing something here. Maybe I open a TIRA but make nondeductible contributions? Thanks.
Douglas
Permalink Submitted by mk foss on Sat, 2011-04-09 19:24
That’s exactly what you do. You merely open a traditional IRA and file Form 8606 with your 1040 to show that the contribution is nondeductible. The custodian has no responsibility for keeping tracl of nondeductible contributions – they’re all just traditional IRAs as far as they’re concerned.
I’m disappomted that the person at the credit union didn’t know that.
Permalink Submitted by John Hamilton on Mon, 2011-04-11 19:49
My daughter is in the same category with the income issue. We were working on her taxes yesterday and on the 8606 form in particular.
Let me give you some history on her process.
April 7, 09 she put $2500 in a Roth for 2008 tax year.
April 7, 09 she put $2500 in a traditional IRA for 2008 tax year
April 14, 2010 she contributed $5000.00 to a non deductible traditional IRA for 2009 tax year.
May 17, 2010 she converted the April 14, 2010 non deductible traditional IRA to a Roth.
We did the April 14, 2010 contribution for the express purpose of converting to a Roth, which we did on May 17, 2010.
By filling out for 8606 it seems that we are being taxed on part of the conversion money. This was non deductible contribution so it was bought with after tax dollars so why are we being taxed again.
If we are being taxed and this is correct would it not be better to leave the non deductible traditional IRA as it is and not convert it?
I know that converting a regular pretax IRA is a taxable move but this is with after tax money.
Waiting for any advice.
Thanks
Permalink Submitted by Alan Spross on Mon, 2011-04-11 20:35
Perhaps the problem is due to the fact that she has other traditional IRA accounts of some size. Your post shows a 2,500 TIRA contribution for 2008 that may have been deductible.
The key is that all of her TIRA accounts are treated as one combined account for tax purposes. She cannot isolate her non deductible contributions to any single account and ignore the others. Therefore, if we assume her ownly IRA balances are the 2,500 and she deducted it and the 5,000 she did not deduct, and assume no earnings, the conversion of the 5,000 account would be 33.3% taxable.
Is this what the 8606 is producing?
Permalink Submitted by John Hamilton on Mon, 2011-04-11 23:34
Alan, thanks for the reply but I had a mistake in her $2500.00 contribution for 2008. This was a nondeductible TIRA. She had no other TIRA at this time. All of her investments were in 401K’s
Sorry for the mistake.
Thanks
jrhami
Permalink Submitted by Alan Spross on Mon, 2011-04-11 23:47
Then there were 7,500 of non deductible contributions that should show on the 8606 for each year of contribution. The conversion was only part of the total value, ie 5,000. But if the total value of both IRAs were more than 7,500, then some of the conversion is taxable.
Example: 2,500 IRA was not converted and grew to 2,800 by year end 2010.
The 5,000 contribution may have been made to the same IRA or a new IRA. It does not matter because you must consider the total values anyway. But let’s assum it was made to the same account as the 2,500. Form 8606 would result in 3.8% of the conversion being taxable. 5,000 converted and 190 taxable. This is all computed on Form 8606, so if you follow the form line by line you will get the correct result. There should never be double taxation on any of the dollars.
Permalink Submitted by John Hamilton on Tue, 2011-04-12 16:12
Thanks for the reply Alan
I am repeating the correct info here for you.
[b]Let me give you some history on her process.
April 7, 09 she put $2500 in a Roth for 2008 tax year.
April 7, 09 she put $2500 in a non deductible traditional IRA for 2008 tax year
April 14, 2010 she contributed $5000.00 to a non deductible traditional IRA for 2009 tax year.
May 17, 2010 she converted the April 14, 2010 non deductible traditional IRA to a Roth.
[/b]
I suppose you get the 7500 from the April 7, 09 $2500 non deductible and the April 14, 2010 $5000 non deductible contribution.
We have the following so far on 8606 form
Line 1—-$5000 for 2010 non deductible to be made now.
Line 2—-$2500 the Roth contribution in April 9, 2009 for the 2008 tax year
Line 3 $7500 total
Line 4—-$5000
Line 5—-$2500
Line 6—-$4394 all traditional IRA total Dec. 31, 2010 should this also include the ROTH conversion?
Line 7—-$ 0
Line 8—-$5000
Line 9—-$9394
Line 10—0.266
Line 11—$1331
Line 12—$ 0
Line 13—$1331
Line 14—$6169
Line 15—-0
Line 16—$5000
Line 17—$1331
Line 18—$3669
Where are we going wrong on the form?
Should line 1 be $10000.00 the total of the contribution of 4/15/2010 plus the $5000 we are making now?
I know we should not be taxed more than 1 time on the money but cannot get it right on 8606.
Thanks again for your help
jrhami
Permalink Submitted by Alan Spross on Tue, 2011-04-12 18:19
The 8606 is incorrect and that is why you are getting the tax bill.
The following lines should be changed from your post:
Line 4 is -0- because none of the regular contributions were made during 2011.
Line 5 is 7500.
Line 10 is .798
Line 11 is 3990
Line 13 is 3990
Line 14 is 3510
Line 15 is 0
Line 16 is 5,000
Line 17 is 3,990
Line 18 is 1,010, the taxable amount.
Probably should have converted the entire balance since the % of basis is so high. Still has 3510 of basis to use in future conversions.
Permalink Submitted by John Hamilton on Wed, 2011-04-13 18:08
Alan,
Thanks for the help in this problem. You are a great asset to this forum.
Your comment about converting the entire amount is correct. Am I correct in saying that the only thing adding to the basis at this time is earnings? She could go ahead and convert the remaining basis and get rid of that. The basis could go down if the market tanks, correct?
My daughter is thinking about discontinuing the non deductible contributions because it is so confusing. I told her no because this is the only way she can add to her ROTH. Any suggestions welcome.
Again
Many thanks
jrhami
Permalink Submitted by Alan Spross on Wed, 2011-04-13 20:07
No, the basis is a fixed dollar amount, but if there are positive earnings the earnings are not basis and therefore the basis % of the total drops. Losses do the reverse, making the basis a higher % of the balance.
Right now, if the value of the TIRA is 4395 and the remaining basis is 3510, a full conversion would produce taxable income of 885. But if she waits and the account earns 500 before she converted, the taxable amount would be 1385 instead. It gets somewhat simpler if she converts the remainder and then has no carryover basis going into the following year.