Traditional IRA Conversion v Non-Deductible IRA Conversion
We have a client ( age 50 ) who has a Traditional IRA valued at $ 500,000.00. He also has a Non-Deductible IRA that is valued at $ 50,000.00 with a cost basis of $ 40,000.00. He is considering converting the Non-Deductible IRA to his Roth IRA. Other than the $ 10,000.00 of gain, are we forgetting anything from a tax standpoint?
Permalink Submitted by Alan - IRA critic on Sun, 2021-02-21 18:56
Yes. There is no such thing as a non deductible TIRA account. IRA basis is spread over all TIRA, SEP IRA, and SIMPLE IRA account that are owned, and not attached to any one of those accounts. Therefore, client has 40,000 of basis in his IRA accounts which are valued at 550,000. That’s about 7.3%, so no matter which account funds the conversion and regardless of the amount converted, 7.3% of the conversion will be non taxable and 92.7% will be taxable. The conversion would be reported on Form 8606 and line 6 must show the total year end value of all of these non Roth IRAs. From there the form generates the calculation of the taxable and non taxable portions converted.
The only way around this is to roll 510,000 into his current employer plan, if it will accept IRA rollovers. That leaves only 40,000 in his IRA which is all basis and he can convert that 40,000 tax free. After the rollover and conversion, he could do annual back door Roths if he does not qualify for regular Roth contributions due to income. The back door process involves making a non deductible TIRA contribution and immediately converting it to a Roth IRA, which would be a non taxable conversion. However, even if his employer plan would accept the 510,000 rollover, if the plan expenses are much higher than what he can get in his IRA, he would not want to leave this rollover in the employer plan for long. After the end of the conversion year, he would probably roll the 510,000 back out of the employer plan. He could not do annual back door Roths if he rolled the funds back to an IRA, but at least he will have been able to convert the 40,000 tax free.
If the rollover cannot be done now or later, he is stuck with these pro rata rules for all his future distributions, including his RMDs which start at 72.