Roth convert now vs wait?

Submitted by fairira on Thu, 2011-12-29 19:52

The owner of a nondeductible TIRA contributed $15,000. in the last few years to this IRA. The IRA’s current value is about $14,000.

Q. 1: What reason, if any, is there to waiting to Roth convert it rather than doing so now?

Q. 2: Is there any way to recapture the $1,000. loss?



Submitted by mk foss on Thu, 2011-12-29 23:02

Is this the individual’s only IRA? If it is and if it were cashed out, the $1,000 loss in value becomes a miscellaneious deduction subject to the 2% limitation. Not a very beneficial, especially if the taxpayer is subject to AMT.

If it were me, I would put off a Roth conversion until the value is over the $15,000 I contributed. A conversion while the value is less than the basis would never allow all of the basis to be recovered tax-free.



Submitted by Alan Spross on Thu, 2011-12-29 23:32

I think you want it assumed that this is the owner’s only TIRA account, since basis applies over all owned IRAs. The IRS Regs do not make it clear exactly what is to happen to the unused basis. Here are the possibilities:

1) The remaining basis of 1,000 stays with the TIRA indefinitely until it can be applied. However, Form 8606 is not designed to show that 1,000 on line 14, so this might be a tough sell with the IRS.
2) The remaining basis is applied by using it to claim a misc itemized deduction or to fill out the 2% to combine with other such misc deductions
3) The remaining basis transfers to the Roth IRA, which does not seem likely except that this is exactly what happens when a designated Roth account is tranferred to a Roth IRA and basis exceeds the value of the account. Again, no specific guidance to support this option.
4) Wait until it grows to 15,000 before converting.

Accordingly, if the misc deduction does not work in the current year, it might be best to convert 13,900 and keep 100 in the TIRA. Form 8606 will then show 1,100 of basis left for future use.

Another option if owner is eligible to make a deductible contribution would be to make a deductible contribution first of 1,000, then convert all 15,000 tax free.



Submitted by fairira on Fri, 2011-12-30 01:55

Thank you, Mary Kay and Alan, for your informative replies.

Sorry that I failed to state that this is the owner’s only TIRA and that his income for the foreseeable future will continue to make him ineligible to make a deductible IRA contribution. Also, his significant income and his lack of any other miscellaneous itemized deductions makes it most unlikely that he will ever be able to apply the $1,000. to this category of deduction.

Mary Kay, you said, “A conversion while the value is less than the basis would never allow all of the basis to be recovered tax-free.” This is true but since any future growth in the value of the TIRA holdings would be the same whether retained in the TIRA or converted now to a Roth IRA, it seems to me that there would be no tax or other advantage to keeping them in the TIRA vs Roth converting them now, except for the possibility in the next paragraph.

Alan, re keeping $100. or so in the TIRA: The owner has a 401k, his contributions to it are all deductible and he does not expect to retire for about 20 years since he is now 48 years old. Q. 1: Assuming that he holds the TIRA open till his retirement in 2030 and that NUA would not then apply to his 401k and that the relevant tax rules do not change by then, upon retiring would he be able to transfer $1,000. from his 401k to his TIRA to raise its basis to $15,000. and then to Roth convert it (at no tax cost)? Q. 2: If his plan permits, could he now transfer $1,000. from his 401k to his TIRA without any adverse consequences ?



Submitted by Alan Spross on Fri, 2011-12-30 03:21

1) Yes, but your question appears to assume that the first conversion never happened (converting 13,900 would use up that much basis reducing the basis to 1,100). If $100 was retained in the TIRA with a basis of 1,100, then a transfer of 1,000 from the 401k would result in being able to apply the basis to the TIRA balance of 1,100 and to convert it tax free. The plan would have to permit a partial distribution and the balance of the 401k could not be rolled over until the year after the conversion. That would eliminate all basis from the IRA and there would be no more pro rating or Form 8606 requirements after the conversion year.

2) Some plans allow in service distributions of certain segments of the plan balance, eg after tax contributions (which would just increase basis if rolled to the TIRA) and the earnings on the after tax contributions. If the plan allowed this, once the earnings on the after tax contributions reached 1,000, he could do the rollover and convert tax free.

But if there can be no after tax contributions, at 59.5 he might be allowed a partial distribution of certain pre tax amounts, and then he could transfer the 1,000 pre tax amount to the TIRA and convert.

Another option assuming he does not qualify for deductible TIRA contributions is to make make non deductible contributions to the TIRA. Eventually given enough non deductible contributions he would generate at least 1,000 of earnings and could then convert tax free.



Submitted by Peter Lingane on Fri, 2011-12-30 03:46

The suggested options are to convert today, when the cost of conversion is the tax on $14,000 or to convert tomorrow when the cost is the tax on $15,000. It would seem wise to convert when there is less tax since the future value of the Roth IRA is independent of the conversion date.

But there are other considerations.

• Perhaps the participant lacks the funds to pay the tax on $14,000 today but hopes to have enough to pay the tax on $15,000 tomorrow. This participant has no option but to wait.

• Perhaps the participant has enough to pay the tax on $14,000 but has chosen to invest the money at essentially no return in a money market account. He or she has no option but to convert now since there will not be enough money to pay the tax on $15,000.

• Perhaps the participant has the money to pay today’s tax invested in a 3x leveraged ETF such that a 7% rise in the value of the IRA (from $14,000 to $15,000) will result in a 21% rise in the value of the money set aside for tax. He or she should probably wait.

• Perhaps the participant is about to retire and expects his tax rate to be lower tomorrow. This participant is better off paying 10% tax on a $15,000 conversion tomorrow than 25% tax on a $14,000 conversion today.

• Perhaps the participant’s heir is a charity. The charity probably receives more without conversion.

The fact that the IRA was previously worth $15,000 is not relevant.



Submitted by fairira on Fri, 2011-12-30 05:29

Peter,

The TIRA is a nondeductible IRA. That is, all contributions were nondeductible.

Since there was no gain in value, no tax is due if this TIRA is converted to a Roth IRA.



Submitted by fairira on Sat, 2011-12-31 01:34

Alan,

Thank you for your further comments on Dec. 30.

Of course you are correct that if $100. is retained in the TIRA, its basis would decline to $1,100. after the conversion of $13,900.

Thank you especially for your years of expert help on this IRA discussion forum to what must by now be thousands of people.

I’m certain that all of us wish you and your family members A Happy New Year and many great years to come.

Eli



Submitted by Alan Spross on Sat, 2011-12-31 03:54

Same to you Eli.

You always pose some of the most interesting and challenging questions.



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