NonDed TIRA to Roth IRA conversion and then Rollover IRA
Hello,
I am hoping to get everyone’s thoughts on this situation below.
1. I contributed $5,000 to Non-Deductible Traditional IRA for *2011* in March 2012 (previous year contribution).
2. I converted that to Roth IRA a day later – $4,964 worth of distributions. When I made this conversion in March, I didn’t have any other Traditional IRA accounts and I converted the entire $5000 I contributed.
3. But my professional situation changed and I left my company in May 2012. I rolled-over my 401K into Roll-Over IRA (~100K). I started a LLC (with myself as an employee) and I am *planning* to open a SEP-IRA and contribute about $20K into that.
4. I am assuming this means, I will have to pay taxes on 96% of $4,964 (if I calculated the cost-basis right?). I didn’t include my Roth IRA money in the Denominator of the Pro-rata calculation. I only included – 100K (roll-over), 20K (future sep ira money by 12/31/2012). Effectively, if I will be paying taxes on ~$5K twice ?
If I am reading the situation correctly, I think I have 2 choices.
1. One idea is to open a Solo-401K at Fidelity and convert my Rollover IRA into that (I can do that right? RollOver is already at Fidelity). And, contribute the (future) Sep IRA money into Solo 401K instead. In this case, I will not have any money in Traditional IRA (Traditional or Rollover or SEP) by 12/31/2012 and I don’t have to worry about Pro-rata rule – having no Trad IRA or Rollover or SEP by 12/31/2012 is all it matter, right? (I will still have Roth IRA). Am I missing something?
2. Or convert the $4,964 back into NonDedTrad IRA and leave it there for now?
Not sure if there are any other options or if there is an option above that is preferable..
Thanks for your help.
-Xanadu
Permalink Submitted by Alan Spross on Mon, 2012-07-23 22:34
Your 96% taxable calculation is correct, although that could be reduced somewhat by not making your 2012 SEP IRA contribution until 2013. You probably would not know your allowed contribution amount anyway until your return is prepared.
Yes, you could recharacterize your Roth IRA conversion back to your TIRA if you wanted to. That would erase the conversion and it’s tax bill.
You are also correct in excluding your Roth values from these pro rate calculations.
You could open the solo K and discontinue the SEP IRA. Make sure the solo K provisions allow incoming IRA rollovers. If you complete the pre tax value of your IRA rollover to the solo K before year end, your conversion will be tax free. You could keep $36 in your IRA in your IRA if you wanted to and convert it when you make next year’s non deductible TIRA contribution, because you have that much basis remaining that you did not use with the 4,964 conversion.
Permalink Submitted by Raghu Akkapeddi on Tue, 2012-07-24 03:56
Thanks. You were very patient and addressed every aspect of my original post. I really appreciate the diligence!
1. Thanks for the confirmation regarding the 96%.
2. Also, good idea regarding waiting till 2013 for SEP IRA contribution to lower my taxable. But I don’t think I will go down the path of Sep-IRA unless I have to!
3. And, even if I go down the Solo 401(K), I need to wait for the tax return to be prepared to determine how much I am contributing to my Solo-401(k), right?
4. I could recharacterize back to TIRA but is there any reason I should? Are there any disadvantages if I go down converting Rollover IRA into Solo 401(k) and contribute new money into Solo 401(K) (instead of Sep-IRA). What is the catch with this approach?
5. Thanks for letting me know about making sure the new Solo-401K accepts incoming Rollover IRAs (I think Fidelity does – my current Rollover IRA is already with them). I will check with them again before opening my Solo 401(k).
6. Can you please explain about the $36 logic below. I added the $5000 for **2011-IRA** and by the time I converted to Roth IRA, it was $4964 (I lost $36 in a day or two). I haven’t contributed anything to *2012-IRA* yet.
7. If I can “hide” all my Traditional IRAs (RollOver IRA and not yet open SEP), I can still contribute $5000 to 2012-IRA and convert that too (hopefully when it is closer to $5040-5,050) to compensate for the $36 losss. In that case, will I get 2 1099-Rs ? or will I get 1 1099-R with ~10,000 as base. I will go down adding the additional 5K only after I can confirm that Solo 401(K) is set – else, I have to worry about paying taxes on $10,000 instead of $5000! Or I will just add and convert the new money into Roth next year – so I can deal with only 1 1099-R for this year. Just thinking out loud.
8. Also, I contributed about $8,500 already to my 401 (K) with my ex-employer. Will I be eligible to contribute another $8,000 (total of $16,500) and then 25% of net income?
Thanks again. Really really appreciate the detail.
Permalink Submitted by Alan Spross on Tue, 2012-07-24 17:34
3) You would need the tax return to determine the profit sharing contribution for the solo K. It is based on your net earnings from self employment. You could make some deferral contributions before that time, but you would have to reduce the 17k max by the amount of salary deferrals you already made this year. Leaves the balance at 9k solo k deferral.
4) If you opt for the solo K you would not recharacterize the conversion you already did since rolling your pre tax IRA balance into the solo K before year end would result in the conversion being tax free. You would only recharacterize the conversion if you opted to pass on the solo K and did not want to pay taxes on the conversion. There is no disadvantage of rolling pre tax IRA money into solo K, just the work to set up the plan and execute the rollover.
6) The reason to leave the $36 of pre tax amounts in your IRA is because you have 5000 in basis and your conversion only used up 4964. You could therefore convert the 36 tax free when you do your next conversion, ie contribute 5k to bring balance to 5,036 and convert it tax free. You would have new basis of another 5k after making your 2013 contribution. You only get one 1099R per year per account. If you do more than one conversion in the same year, they are added together on the 1099R.