Conversion of non-deductible Traditional IRA to Roth

Submitted by Deep Chand on Wed, 2011-04-13 03:17

Here’s a bit of historical reference for some quick context setting-
For the 2009 tax year, I filed my taxes using TurboTax and somehow ended up making a non-deductible contribution of $5000 to a Traditional IRA account.
Got married in 2010 and filed taxes jointly 2 weeks ago using the services of a tax consultant. Per our combined AGI and as per the filed return, we are allowed and supposed to make $2500 contributions each to our respective Roth accounts prior to the 18th of this month.

Qns –
1. Is it possible to convert a portion (i.e. $2500) of my existent non-deducted $5000 from a Traditional IRA to a Roth?
2. If so, what forms am I reqd to complete, given that I have already filed my taxes for 2010? Are there any tax implications?
3. Is it possible to convert or transfer $2500 of my non-deducted traditional IRA holdings to my wife’s Roth?

The $5000 from my 2009 traditional IRA is currently invested in stocks that is under water and I’d prefer not to sell these as part of converting the account.

When I posed the above qns to the rep at Scottrade, he pointed me to my tax agent. The tax agent pointed me back to Scottrade. Upon pressing my agent further, he thought about it for a while and then stated that I should be able to convert the account without any tax implications. However, he didn’t sound too confident… which is why I’d like to run it by some experts…just to make sure that I’m doing the right thing. Your timely advise is sincerely appreciated.

Regards,
Deep



Submitted by Alan Spross on Wed, 2011-04-13 03:44

1) You can convert any portion you wish to a Roth IRA. You should have filed an 8606 on your 2009 return showing the non deductible contribution. If that is your only TIRA (traditional IRA) contribution, your conversion will be tax free because the value has dropped below what you contributed. If you have any other TIRA accounts at all, you must factor in the value of all of them to determine the taxes on your conversion.
2) Any conversion you do in 2011 is not reported until your 2011 return. These are not like regular contributions where you can still make them for 2010. A conversion now will not affect your 2010 return.
3) No. IRAs are individual accounts with only one owner, ie there are no JOINT IRA accounts. They cannot be transferred until they are inherited other than in a formal divorce settlement.

The fact that you both can only contribute 2,500 each to a Roth IRA indicates that you are in the income phaseout range for 2010, ie your modified AGI is around 172,000. If you wanted to you could both make additional non deductible TIRA contributions of 2,500 each for 2010 and report them on Form 8606 for 2010. Each of you has your own 8606 form. You could then add that 2,500 to your other conversion and have a single tax free Roth conversion of somewhat less than 7,500. You do not have to sell any of the investments, they are just transferred to a Roth IRA as is.

If you remain in the income phaseout range or certainly if you go above it for 2011 AND DO NOT have any other traditional IRA accounts like a rollover IRA, then you can get around the income limit for making regular Roth contributions by simply making a full 5,000 non deductible TIRA contribution each year and then converting it right away tax free. Both of you could do that even if your wife does not work by making a spousal contribution for her using your earned income.



Submitted by Deep Chand on Wed, 2011-04-13 04:55

First off -Thanks to the power of Google that I stumbled upon this website and a bigger thanks to alan for your subject matter expertise! I was actually on the phone earlier this eve “on hold” waiting to be connected to an IRS agent for a good 80 mins before I decided to hang up and try Googling.

Just to make sure I’m on the same page, is there a difference in terminology as far as the context of this topic goes between “conversion” and “contribution”. i.e. Would a “conversion” of my funds from TIRA to Roth satisfy the need per my 2010 return to “contribute” funds to Roth?

Wrt #1, you’re right. I do have an 8606 from my ’09 return indicating a non-ded TIRA contri (which is my only TIRA contri ’til date). Therefore, as per your deduction, it should be tax exempt since the value has dropped below what I initially contributed. Irrespective, I’m assuming the folks at Scottrade are going to request that I fill up certain forms to transfer the funds betn TIRA and Roth. I will let them know that the conversion should not have any tax implications.
Wrt #2, thanks for the clarification on reporting conversions for the current calendar year tax return as opposed to contributions that can still be made for the prior year.
Wrt #3, it sounds like I would have to amend my already filed return by including form 8606 if we were to contribute addnl funds towards TIRA and convert to Roth.

Once again, thanks for your time and expertise.

Regards,
Deep



Submitted by Alan Spross on Wed, 2011-04-13 22:33

A Roth contribution can be either a regular contribution limited to 5k or 6k or a conversion contribution without a limit. There are income limits for regular contributions but not for conversions.

1) Do not bother to talk to Scottrade regarding the conversion taxes because they process the conversion order the same either way and do not care whether it is taxable or tax free. The tax bill is between you and the IRS according to the Form 8606 you file when you report the conversion.

Point 3) If you make additional non deductible contributions to your TIRA for 2010 by 4/18 and have already filed, you would have to amend your Form 8606 that you already filed. You might be able to file the 8606 by itself without a 1040X, but it would be safer to just have one revised 8606 as part of an amended return to avoid confusion by the IRS.



Submitted by Deep Chand on Thu, 2011-04-14 00:45

Thanks again, Alan! 🙂

So, to reiterate –
[*]If my TIRA from ’09 contribution has $5000 invested in stocks (now under water and for purposes of conversation let’s say valued at $4000) can be converted in its entirety (i.e. with a sticker value of $5000) to Roth. This conversion will only be reported in my ’11 tax filing with the associated 8606 without any tax implications since
a. it is currently undervalued (i.e. I didn’t earn an income on it),
b. was funds from a non-deductible contribution to TIRA to start with &
c. is my only existing TIRA account with the above-mentioned value

[*]Since my ’10 tax return indicates that I will be contributing $2500 towards Roth, this HAS to be a normal contribution and NOT a conversion contribution, correct?

Generally speaking –
1. Is Roth preferred over TIRA considering that you don’t have to pay taxes when the funds mature (since rates could be higher in the future)?
2. It “sounds” like a system loophole if the IRS has a cap (around $5-6k) of yearly contributions depending on your AGI versus no cap for conversions from a TIRA to Roth. So, in short, what prevents me from making $5k non-deductible yearly contribution towards TIRA and having it immediately convert over to Roth?



Submitted by Alan Spross on Thu, 2011-04-14 03:04

Correct for a, b, and c.

*) You do not report regular Roth IRA contributions on your return, ie the 2,500 each of you are contributing for 2010. Yes, these are REGULAR Roth contributions.

1. It depends on several circumstances. Generally, a Roth contribution or conversion is better if you expect your marginal tax rate in retirement to be equal to or higher than your current rate. It is also generally better for Saver types who will accumulate retirement assets vrs spenders who will not have accumulated much for retirement. And yes, tax rates are expected to rise in the future, especially for the brackets about the 25% bracket.
2. Nothing prevents this and it is a good idea to take advantage of this as long as you can. Congress may eventually address this “work around” by either shutting it down or increasing the income limits for regular contributions or some combination of both. For now, there are many people taking advantage of the opportunity.



Submitted by Deep Chand on Thu, 2011-04-14 16:08

Thanks again, Alan! This has been very insightful. 🙂

Cheers!
Deep



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