When Converting a Traditional IRA to a Roth IRA in 2010 – Beware of the Glitches

Funding a tax-deductible Traditional IRA will garner you an immediate tax break, investments grow tax deferred, but withdrawals are taxed as ordinary income.  A Roth doesn’t offer an immediate tax deduction  but investments grow tax deferred and withdrawals are tax free.  Unfortunately, if you are covered by a retirement plan at work and make more than $116,000 if you are single and $169,000 if you are married filing jointly – you can’t contribute to either.

Non deductible IRAs in the past were a very un-popular investment vehicle.  Contributions are not deductible on your tax returns, they grow tax deferred but are withdrawn at regular income tax rates.  However, in 2006 a new law was passed that said in 2010 individuals who were restricted from contributing to a Roth IRA are allowed to convert their non deductible and deductible Traditional IRAs to Roth IRAs regardless of salary. 

Converting your non deductible to a Roth in 2010 without paying additional taxes is an excellent strategy.  However, be careful not to trigger more tax liability!  Lets say you have $100,000 in a regular Traditional IRA and $25,000 in a non-deductible account.  You would owe taxes on the $21,000 because it would be assumed that the $25,000 was coming pro rata from the whole IRA rather than just the non deductible IRA.  You don’t want to pay taxes twice so what can you do? 

Solution #1: Roll the deductible portion of your Traditional IRA into a 401(k) if allowed.  Then when you go to roll over the non deductible portion into a Roth you will not be double taxed!

Solution #2: Even if you have a large IRA that you don’t want to mingle with non deductible IRA money to be converted, your spouse may not.  If not, your spouse can fund a non deductible IRA until 2010 and then convert it to a Roth.


4 Responses to “When Converting a Traditional IRA to a Roth IRA in 2010 – Beware of the Glitches”

  1. Jeff Ryan Says:

    I only invest up to the match in my 401(k), max out my Roth contribution, then continue to invest in my 401(k)… I try to make sure I’m saving about 15-20% of my gross income.

    The Roth IRA is a phenominal investment vehicle. While you do not get a tax deduction on the contributions, the investment universe is open to you. More importantly, your withdrawls are tax free once you turn 59 1/2! I’ll take that over a stupid tax deduction any day.

    Good article.

  2. Pat K. Says:

    Thanks for the info Nicole. I have a deductible IRA and a non-deductible IRA. If I convert them both to Roth in 2010, does the double taxation problem go away?

  3. Karla Says:

    Where is “$21,000” coming from? How did you get $21,000 from $100,000 and $25,000?

  4. How to Get Six Pack Fast Says:

    After reading through the article, I just feel that I need more info. Can you suggest some more resources ?

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