Converting Deductible & Non-deductible TIRA to Roth IRA
Recently your associate, Sarah Brenner published in her newsletter that under today’s potential for tax law changes, it may be advisable to convert non-deductible tax TIRA to Roth IRA. She wrote,
“currently the back door Roth IRA conversion allows an individual to make a nondeductible after-tax contribution to a traditional IRA and then convert it tax-free to a Roth IRA”
That seems in conflict with another rule that once the funds in deductible TIRA are mixed with the non-deductible IRA they cannot be separated. The tax laws compel the owners to pay taxes on the RMD based on the total TIRA proportionately through IRS Form 8606.
I have been doing just that for years since my TIRA has both deductible and non-deductible funds. I was told that separating the two was impossible. (Like trying to separate cream mixed in coffee) !! Did I misunderstand Sarah’s viewpoint?
Permalink Submitted by Alan - IRA critic on Tue, 2021-10-05 19:09
Yes. Her statement assumes that the IRA owner has no pre tax balance in any TIRA, SEP IRA, or SIMPLE IRA, just the non deductible contribution. Since there are no pre tax balances to pro rate, this conversion will be tax free. For others that have current IRA pre tax balances, the taxable portion of any conversion (or any non converted distribution) will be determined on Form 8606 using the pro rate rules.
Since you have pre tax balances in your IRA which probably far exceed your IRA basis, your RMDs are mostly taxable. Many IRA owners have small amount of IRA basis, often under 5% of total IRA balances. So you will be filing Form 8606 every year to recover a small portion of your IRA basis each year tax free. Any QCDs you do automatically come solely from your pre tax IRA balance, so if you do a QCD as part of your RMD, the non QCD portion will be pro rated, but the QCD will not be reported on Form 8606.
Since you are subject to RMDs, you can only convert after your RMD has been completed. The taxable portion of both your RMD (except any QCDs) and your conversion will be the same % of these distributions.