Converting non-deductible IRA to a Roth?

Submitted by Jack Thomas on Thu, 2014-05-01 18:30

Scenario:

Husband unemployed, wife makes 250k and is covered by a plan at work. Therefore, husband cannot do a Roth or a traditional IRA. Can the husband contribute to a non-deductible IRA and then convert it to a Roth?

Husband also as a rollover IRA from a previous employer, so in converting a non-deductible IRA to a Roth (if this is even possible), what could be the tax implications?

My understanding is that the husband would need to take into consideration all IRAs when converting to a Roth in figuring the taxable amount of the conversion. So in other words, could the non-deductible IRA be a fully taxable conversion based on other funds he has in a rollover IRA?

It almost seems like the husband would be taxed twice on getting the funds into a Roth IRA since the funds were initially after tax to begin with and the conversion would trigger another taxable event.

Is that correct? Could there be another strategy for husband to get funds into a Roth IRA?



Submitted by Alan - IRA critic on Thu, 2014-05-01 19:21

You are basically correct. The rollover IRA would make the conversion mostly taxable regardless of the amount that was converted. The only solution to this is to roll the rollover IRA back into his current employer plan if he is still working and his current plan will accept IRA rollovers. That would eliminate the rollover IRA from line 6 of Form 8606 and his conversion would then be tax free and the strategy could be repeated in future years.

Submitted by Jack Thomas on Thu, 2014-05-01 21:04

Very helpful once again.  Then my follow up question would be, if the husband is younger than age 59 1/2, would he be able to withdraw converted amounts without penalty if waits 5 years (say for example he is 45) and then wait till age 59 1/2 to withdraw earnings tax free?

Submitted by Alan - IRA critic on Thu, 2014-05-01 21:24

Yes, after 5 years or 59.5 which comes first he could withdraw conversions without penalty. Once the Roth is qualified all distributions are tax and penalty free (5 years AND 59.5). If the conversion is mostly taxable due to the rollover IRA, at the end there is no double taxation because he will recover the non deducted amount eventually, but it will take his entire lifetime because of the pro rate rules. But the taxes are front loaded at the time of the conversion

Submitted by Jack Thomas on Thu, 2014-05-01 22:03

Could you please explain again what you mean by there is no double taxation at the end and that he will recover the non deducted amount eventually?  For some reason I’m not getting that.

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