Have you made non-deductible contributions to a Traditional IRA? If so, want to convert these non-deductible contributions to a Roth IRA. This may be an attractive option for you since only the earnings in a non-deductible Traditional IRA are taxed upon conversion, there are no taxes assessed on the original contributions made.
Because the IRS bases tax liability on the type of contribution originally made and whether there are any earnings, it is important to analyze the balances within any Traditional IRA you contemplate converting to a Roth IRA. If you’ve made both non-deductible and deductible contributions to your Traditional IRA (or if it contains earnings), then a portion of your conversion will be taxable. Unfortunately, the IRS doesn’t allow you to convert only the non-deductible portion of an IRA. The “pro rata” rules that apply to regular distributions from a Traditional IRA also apply to conversions.
So how do these rules work? First, in order to calculate the tax on a proposed conversion, you will need to add up the total current value of all of your Traditional IRAs. Then out of that total value, determine how much, or what percentage, represents non-deductible contributions made to the IRAs. This percentage is then multiplied against the conversion amount to determine the amount that is non-taxable. The remaining amount would represent the taxable portion. For example, if 60% of the total IRA balances come from non-deductible contributions and $8,000 from one of the IRAs is converted to a Roth IRA, then 60% of the converted amount (or $4,800) is not subject to taxes. 40% of the converted amount, or $3,200, is reported as income for income tax purposes.
If you are interested in converting to a Roth IRA, but only want to convert your original non-deductible contributions and pay no taxes on the conversion, there is a strategy that may help you achieve this goal. If your current employer offers a qualified plan, and the plan accepts rollover assets, you may be able to reduce the balances in your Traditional IRA and minimize the effect of the pro rata rules. If you roll over the pre-tax assets (such as deductible contributions, rollovers from former employer plans, and any earnings) from your IRAs, into your current employer’s qualified plan, this would leave only the non-deductible contributions in your Traditional or Rollover IRAs. You can then convert these contributions tax-free to a Roth IRA! Because assets in employer-sponsored qualified retirement plans, such as 401(k) plans, aren’t included in pro rata calculations, moving all of your pre-tax IRA assets to an employer plan, will allow you to convert the entire balance of your Traditional IRA without triggering the pro rata calculation.
If you don’t currently have a non-deductible IRA, opening and funding one is simple. First, open both a Traditional IRA and a Roth IRA. Then, fund the Traditional IRA with up to $5,500, or up to $6,500 if you are over age 50. Finally, request a Roth IRA conversion online. It’s that easy! You can select to transfer your entire account or a partial amount of cash and/or securities. We will not liquidate any securities, but instead will transfer them in-kind. The movement of assets from your Traditional IRA to your Roth IRA will be processed within 1 – 2 business days. Or if you prefer, you can call into our Customer Service department or visit one of our branches and they can process your request over the phone or in-person just as easily. There are no forms for you to sign and mail.