ROTH Conversions and 401k Rollover
I have a high income client with no IRAs but a couple of 401ks. I have counseled her to create and fund a non-deductible IRA, and then immediately convert it to a Roth since there are no income restrictions on conversions. As I mentioned, she also has an old 401k that she’s looking to rollover to an IRA. Let’s say she makes the Roth conversion in May 2011. Later in 2011, she rolls over the 401k into an IRA. Does that mean her conversion would essentially be fully taxable since the basis would have to be allocated to all her IRAs, not just the one she converted? Would it make more sense to hold off on rolling the 401k until 2012 to avoid any taxation on the conversion? Thanks for your help.
Permalink Submitted by Alan Spross on Thu, 2011-05-19 21:10
Yes, as you suspected, doing the rollover in the same year as the conversion will dilute the basis on Form 8606 and the conversion will be mostly all taxable. Worse yet, doing that rollover will eliminate the possibility of tax free conversions of non deductible TIRA contributions for future years as well.
One possibility is to have the old 401k balances transferred into the current 401k if she has one and then the non deductible TIRA contribution strategy could be continued every year. There are other options to consider if these old plans hold any after tax dollars. If so, there is a way to isolate the basis to get the after tax dollars into a Roth IRA, but since the pre tax dollars will go to a TIRA, that will also end the non deductible contribution strategy. Therefore, the strategy is effected by how many after tax dollars already exist in these plans vrs what could be contributed in regular IRA contributions.