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March 6, 2009

Can an individual convert ( to a Roth IRA) only the nontaxable amounts in his traditional IRA?

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Can an individual convert ( to a Roth IRA) only the nontaxable amounts in his traditional IRA?

QuestionAn individual has two http://retirementdictionary.com/definitions/traditionalira traditional IRAs and a http://retirementdictionary.com/definitions/simplifiedemployeepensionsepira SEP IRA. The SEP IRA has only pre-tax amounts, as it was funded with only SEP employer contributions. One of the traditional IRAs includes http://retirementdictionary.com/definitions/rollovercontribution rollovers of pre-tax amounts from a http://retirementdictionary.com/definitions/profitsharingplan profit sharing plan, and the other holds nondeductible IRA contributions made over the years.Can the individual choose to convert only the http://retirementdictionary.com/definitions/nondeductiblecontribution nondeductible IRA amounts to a http://retirementdictionary.com/definitions/rothira Roth IRA?

Answer

No. For purposes of determining the taxable portion of a http://retirementdictionary.com/definitions/rothiraconversion Roth IRA conversion or a http://retirementdictionary.com/definitions/distribution distribution from an individual’s traditional IRA, SEP IRA or SIMPLE IRA, all of the individual’s traditional IRAs, SEP IRAs and SIMPLE IRAs are treated as one account, and the amount converted to a Roth IRA or otherwise distributed from any of those accounts include prorated pre-tax and post-tax amounts. Let’s look at an example:

TJ has the following accounts:
• Traditional IRA # 1 with $20,000 post-tax amounts
• Traditional IRA # 2 with $50,000 pre-tax amounts
• SEP IRA with $30,000 pre-tax amounts
Total = $100,000

TJ converts Traditional IRA # 1 ($20,000 balance) to his Roth IRA

Results:

For tax purposes, the conversion includes $4,000 post-tax (nontaxable) amounts and $16,000 pre-tax (taxable) amounts, determined as follows:

• Total IRA balance: $20,000 + $50,000 + $30,000 = $100,000
• Nontaxable balance is 1/5 or 20%: $20,000/$100,000= 1/5 [nontaxable/taxable]
• Nontaxable Converted amount is: $20,000 x 1/5 (or 20%)=$4,000
• $16,000 will be taxable

Question answered by http://deniseappleby.com/ Denise Appleby

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at http://irapublications.com. Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.

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