How To Convert A Non-Deductible IRA To A Roth IRA

So you want to contribute to a Roth IRA, but you make too much money, and your employer doesn’t offer a Roth 401(k) eh? If your Adjusted Gross Income (AGI) is higher than $110,000 (or $173,000 if married), you can’t contribute directly to a Roth IRA for 2012. But what if you REALLY want to contribute to a Roth IRA? There IS a way!

Non-deductible Traditional IRA contributions allow high income earners to get some of the tax benefits of IRA’s, but not all of them. Money put into a Traditional IRA is normally tax deductible, grows tax deferred, and is taxed when you take the money out in retirement. As the name suggests, non-deductible IRA contributions don’t give you a tax deduction, however the money grows tax deferred, and only the growth is taxable when you take it out in retirement.

Roth IRA’s are not tax deductible either, but the growth is never taxed! You can see why someone would much rather have money in a Roth IRA as opposed to having non-deductible IRA contributions… huge tax savings on the growth! This is why many people would want to convert their non-deductible IRA contributions to a Roth IRA.

As recently as 2009, you could only convert an IRA to a Roth IRA if your income was below $100,000. But in 2010, those limitations were eliminated so now there are NO income limits on IRA conversions.

So if you want to put money into a Roth IRA, but make too much money, here’s what you can do:
Step 1: Open new Traditional IRA
Step 2: Make a non-deductible contribution to your IRA (Maximum of $5,000 for 2012, $6,000 if over 50)
Step 3: Open new Roth IRA
Step 4: Tell the custodian of your IRA that you want to do a Roth conversion

That’s it! Plus, you can do this for each you and your spouse… There are a couple of things to remember when doing the conversion:

After contributing to the non-deductible IRA, wait at least 30 days before converting to the Roth IRA. Some experts recommend waiting until the next year. This helps establish a paper trail of the conversion.

Be sure to open a new Roth IRA for the conversion. If the IRS calls the conversion into question, the entire Roth IRA  might lose its preferred tax status. You don’t want to expose your current Roth IRA to this risk.

Don’t forget to file Form 8606 with your tax return. If the IRS ever comes calling, you need to be able to prove that you contributed to a non-deductible IRA. Form 8606 is the proof you MUST have.

Be sure you consult with a financial advisor and/or an accountant before implementing this strategy, especially if you have a Traditional IRA as you may expose yourself to additional taxes.

So what do you think? Thinking about implementing this strategy? Let me know your thoughts or questions!

About the author

Alan Moore, CFP®, MS
Alan Moore, CFP®, MS

Alan is passionate about providing individualized financial advice to individuals and families, regardless of their net worth, income or investable assets. An educator at his core, he strives to serve as his clients’ guide, available to help with the sometimes stressful or exciting financial situations that life inevitably brings.

Alan is the founder of Serenity Financial Consulting, which he started after noticing the lack of hourly, as-needed financial planning advice available to consumers. With experience working in several nationally recognized firms including Kahler Financial Group and Financial Service Group, Alan combines his industry experience and technical knowledge with his entrepreneurial spirit and penchant for teaching others to create a refreshing style of truly personal financial planning.

Alan is a Certified Financial Planner™ professional and Certified Retirement Counselor™. He earned his bachelor’s degrees in Family Financial Planning and Consumer Economics and his Master’s Degree in Family Financial Planning from the University of Georgia. Driven by his desire to educate, Alan also taught undergraduate financial planning courses while in graduate school.

Alan prides himself on being active in his community and feels privileged to have served in the Georgia National Guard for four years before receiving an honorable discharge. Originally from Georgia, Alan now lives in Shorewood with his wife Melissa, and enjoys taking advantage of the abundance of activities that Milwaukee has to offer.

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