Non-Deductible IRA/ Roth Conversion Example
Client and Spouse about to make $6k each 2011 Non-Ded. IRA Cont. with intent to immediately convert to Roth. Client IRA acct. Client TIRA acct. value 1.3mill. Spouse TIRA bal. $20k. If my math is correct, client $6k conversion would be basically be fully taxable (99.5%) 1.3mill/1,306,000. So it does not seem to make sense to convert this $6k contribution. However, spouse has $20k TIRA balance so 77% of conversion taxable or $4620 of conversion. If she wanted to do this every year and let’s assume the $20k TIRA bal. never changes, would the taxable conversion amount of $4620 be the same every year she elects to convert for a $6k non-ded. IRa contribution? Would it not make sense to go ahead and convert the $20k TIRA to a Roth so that each year going forward none of the full $6k non-ded. IRA contribution would be taxable?
One last thing. When someone converts a non-deductible IRA to Roth, in year of conversion does this count as a Roth contribution? In other words as long as your income qualifies, can you make a Roth contibution in 2012 then later the same year do a full or partial conversion of a TIRA or non-ded. IRA as in example above?
Permalink Submitted by Alan Spross on Fri, 2012-02-03 18:58
The conversion does not affect the ability to make a regular Roth contribution. It does not increase the MAGI for Roth contribution purposes, but not clear if couple’s income is too high for regular Roth contributions or not. Doing regular Roth contributions is preferable before converting, ie make them first, and then convert additional amounts if warranted.
Your math is correct, ie if spouse’s TIRA has no gain or loss and each year a 6k non deductible contribution is added and a 6k conversion is done, every year 77% of the conversion will be taxable. When spouse’s have such a wide variation of potential basis % in their TIRAs, it does make sense to convert the higher basis IRA, and in this case accelerate the total conversion perhaps into a two year period. Spouse could make both the 2011 and 2012 non deductible contributions now and convert 16k to a Roth this year (10,000 taxable), then in 2013 make the 2012 non deductible contribution of 6k and convert the remaining 22k (also 10,000 taxable). That splits the taxable 20,000 into two years equally and the entire TIRA will be converted 12 months from now. Of course, any earnings would add to the taxable income, but spouse would have a 38,000 Roth IRA 12 months from now. That is a more tax efficient use of IRA contributions than to contribute to client’s TIRA and produce a fractional basis to deal with indefinitely and certainly every year once RMDs begin. But this approach should follow making any regular Roth contributions if eligible, particularly for the client.
Permalink Submitted by James Claiborne on Fri, 2012-02-03 21:21
Excellent advice!! Thank you