It appears that you are correctly filing the 8606 reporting the non deductible TIRA contribution you have made. If you have done that, nothing else you will do can cause any double taxation.

The pro rate formula is fairly simple, but it is a good idea to get an 8606 and run some examples. Right now if your TIRA is worth 12,000 and you have made 10,000 of non deductible contributions, you might as well convert the entire amount since you will only be taxed on 2,000. I don’t know if your 2012 contribution is in addition to the 12,000 or not, but either way, a full conversion will only result in taxation of the 2,000 of gains that are in the account. There will be no TIRA values left that can change your 12/31/2012 balance as it will be -0-.

Now suppose you don’t even want to pay the tax on 2,000, but only 1,000. So you convert half the TIRA to a Roth instead of all of it. But here is where the half you have left in the TIRA can change value between now and 12/31. For example, if you have 6,000 left in the TIRA after converting half and that account gains 20% before year end, your year end balance will be 7,200. Because of these gains your 6,000 conversion, your conversion is now 24.2% taxable instead of 20% (Total year end adjusted value 6,000 plus 7,200 divided by 10,000 = 75.8% non taxable and therefore 24.2% taxable. 24.2% of the 6,000 you converted is 1,452. You would end up paying tax on 1,452 instead of just 1,000. In addition, you will still have 1,748 left in the TIRA for the next conversion that is taxable meaning your total taxable amount to convert the entire account is 1452 plus 1748 or 3200. The 3200 represents the gain of 2,000 you started with plus the 1200 gain that occurred in your TIRA after converting half of the original 12,000.

On the other hand, if your remaining 6,000 in the TIRA lost 20% to 4,800 by year end, then the taxable portion of your conversion drops (6,000 plus 4,800 divided by 10,000 = 92.6% non taxable and therefore 7.4% taxable. Your 6,000 conversion will then include only $444 of taxable income.

The above two example show how your conversion taxable amount can change as a result of changing values in the TIRA you have left. But if you convert the entire TIRA right now, you know that your conversion will be taxable in the amount of 2,000 without adjustments since there is no TIRA left. And starting next year you can make your non deductible contribution and convert it right away tax free.

But you are correct that waiting until near year end to convert will give you a better idea of the taxable amount since there is less time for the remaining value to change. But if your TIRA has gains in the meantime it will mean more taxes to pay to convert the entire account.

All this can be confusing, so that is why you should get a Form 8606 and play with various examples.

Since you have such a high % of 8606 basis (10/12 or 83.3%) and a low balance, converting the entire amount now makes sense. That eliminates the need for dealing with future taxable amounts and gets dollars into your Roth IRA sooner.

NOTE: Some people should not convert at all. But since you have such a high % of basis your tax bill will be very low to convert the entire balance.

• Flag as spam
• Log in to Reply

[quote=”[email protected]“]Hello Alan,

Thanks so much for your very, very precise answers to my questions. I think I get most of your explanations and will do run some tests with the 8606 form for some hypothetical outcomes. Just to make sure I understand correct, if I convert now from TIRA to RIRA the issue of the balance at 12/31/2012 is a non-issue as this date is really only about the balance in the TIRA at years end, not the balance in the Roth IRA?

[b][b]Correct.[/b][/b]

Also, I the 12k did not include the 2012 contribution, but by including the 2012 in it my pro rata I guess the calculations goes like 17/15=88.2%, which is actually in my favor, correct? I guess the as IRA’s are by individual person, all of this applies to each individuals TIRA account (as long as each has only one IRA account), and thus could be done for both oneself and spouse, is that correct?

[b]Correct on both. Each spouse has their own 8606 (the form only holds one SSN), and the calculations are separate for each spouse. If you converted the entire 17k, the taxable amount would still be the same 2k, but if you did a partial conversion, the taxable % would drop to 11.8%.[/b]One thing you say is that the taxation is only on the 2k, but isn’t it on 16.33% of the entire amount (16.33% of 12000=1959.6$)… just wanted to see if I understand the pro-rata correctly…?

[b]16.7% which due to rounding = 2004. For a partial conversion it would be 16.7% of the amount converted. Eg convert half (6k), then taxable amount = 1,002.[/b]

You say conversion might not be the right for some folks – which one’s are you referring too? I read multiple times that if you are in a high tax bracket you likely should not convert to Roth and pay taxes on it now, but isn’t that really only an issue if you are converting an account with a high balance, and a low non-deductible ‘cost basis’? As long as you start with a ‘high’ pro-rata ratio when doing your first conversion, you are off pretty well, and can keep your taxation near zero if you put your full contribution in each year into TIRA on one day in a fixed income type of investment, and than convert to Roth IRA the next day and start investing the money in whatever you need to invest in based on your risk/reward and overall investment strategy… do I interpret that correct?

[b]Yes. Having a high % of basis as in your case, the general conversion guideline relating current tax bracket to expected retirement bracket can be ignored.[/b]

N.[/quote]

• Flag as spam
• Log in to Reply