Roth Conversion from non-deductible IRA
I have a client who has a small traditional IRA funded completely with non-deductible contributions. Let’s also say there are no gains in the IRA and client has no other IRAs. If he converts to a Roth, I know there aren’t any taxes in this situation. But what if client also has a substantial pre-tax 401k that he rolls over to an IRA later in the same tax year to a new IRA? Would the original conversion still be tax-exempt since there was no other IRA money at the time of conversion, or would the IRS want the client to pay taxes on the pro-rated portion of the conversion based on the funds rolled over from the 401k?
Permalink Submitted by Alan - IRA critic on Tue, 2013-02-12 17:47
This is a frequent mistake. The pro rating of the taxable portion of the conversion is based on the adjusted year end values of all non Roth IRAs. Therefore, the 401 rollover in the same year results in the earlier conversion being mostly taxable. The values on the actual date of conversion do not matter. This is all generated on Form 8606. If the client objects to the taxes, the conversion can still be recharacterized to eliminate the taxes. Some people who have large rollover IRAs roll the pre tax amount into employer plans leaving only the non deductible amounts behind. Then they can convert the non deductible amount to a Roth IRA tax free and continue to make non deductible contributions and tax free conversions each year.
Permalink Submitted by Pete Simmonds on Tue, 2013-02-12 18:19
Thanks. This is what I suspected.