strategy: contribute to traditional IRA and convert to Roth IRA in 2010

Sadly, the old and glorious thread originally started in 2006 was archived in 2008:

Thanks Ellory

But it's now 2009, and the countdown is on toward 2010, so I would like to revive the discussion.

This thread specifically addresses the strategy of making non-deductible (due to income limits) contributions to a traditional IRA with the plan of converting to a Roth IRA in 2010. Any taxable gains at that time can be dispersed over 2 years (2011 and 2012, so due 4/15/12 and 4/15/13).

Question: I assume one can make their 2010 contributions in early 2010, and then immediately convert to a Roth? Presuming one plans for their IRA to grow over time, it appears that it makes the most sense to contribute the maximum $5000 to the traditional IRA on January 1 2010, and then initiate the conversion on January 2 2010, to minimize eventual taxable gains?

ETA: dates of taxation corrected

psychtobe said: This thread specifically addresses the strategy of making non-deductible (due to income limits) contributions to a traditional IRA with the plan of converting to a Roth IRA in 2010. Any taxable gains at that time can be dispersed over 2 years (2010 and 2011, so due 4/15/11 and 4/15/12).Actually, it's 2011 and 2012 taxable income, meaning the returns you file in 2012 and 2013. You're not just deferring half of the income, you're deferring half for a year and the other half for two years.

Question: I assume one can make their 2010 contributions in early 2010, and then immediately convert to a Roth?Yes.

Presuming one plans for their IRA to grow over time, it appears that it makes the most sense to contribute the maximum $5000 to the traditional IRA on January 1 2010, and then initiate the conversion on January 2 2010, to minimize eventual taxable gains?Not really. Remember, you're paying tax on all of the investment earnings of your non-IRA investments; if you don't contribute the money to an IRA, you'll still be paying tax on it.

So it depends on what you will invest in and how it will be taxed if it's not in an IRA. If it's something that generates capital gains and you're planning to hold it long enough to make them long term, then it will depend on the difference in tax rates and on the value of deferral (which depends on interest rates); you're probably better off delaying the contribution. But if you'll buy something like a bond that will generate ordinary income, you'll be paying tax on that income either way; contributing early just lets you delay the tax on that income (and, with the special 2010 rule, delay it for an extra 1 1/2 years, on average).

xerty said: LH - aren't you answering a slightly different question (like whether it makes sense to contribute for 2009 early vs late)?You're right, that's what I thought psychtobe was asking, but, rereading it, it seems clear that the question was about the timing of the 2010 contribution and conversion, which should definitely be done as soon as possible (if you have the money).

psychtobe said: Can you explain why a conversion in January 2010 would not count as taxable income til 2011 and 2012, meaning taxes filed 2012 and 2013?
Because there's a special exception for doing this in 2010 to encourage you to so. Read more here.

azygous said: HHI: 88K( 44k +44K) me n my wife till 2012 ( we are resident doctors. after that the HHI will increase )
No 401K or any other retirement vehicle at work.

If I put money in traditional IRA its makes our HHI below 52K and helps us to get at least the savers credit and saves taxes..
From what i understood, I should be able to convert my TIRA to Roth in 2010 and pay the federal taxes on that...All that changes in 2010 is that the income limit on conversions goes away (which does not matter to you, for the moment, because you're below the income limit anyway) and there is the special rule about dividing up income over 2011-2012. You are free to convert any time, if you want.

what about the savers credit?? ( is it a part of federal tax)..Eligibility for the savers' credit is based on AGI with some modifications. Assuming all of your IRA contributions have been deductible, when you convert, you will get extra taxable income equal to the full amount converted. So, if you convert, let's say, $20,000, you'll have an extra $20,000 in income that year (or spread over the next 2 years, if it's in 2010), which will count against savers' credit eligibility. You won't forfeit the credit you took in earlier years. But, if you are in a higher bracket when you convert than when you contributed, the tax on the conversion might be a bit painful.

are there any other taxes associated with the conversion...I hope i am understanding this conversion properly..You will probably also owe state and any local income tax on the conversion.

psychtobe said: xerty said: psychtobe said: Can you explain why a conversion in January 2010 would not count as taxable income til 2011 and 2012, meaning taxes filed 2012 and 2013?
Because there's a special exception for doing this in 2010 to encourage you to so. Read more here.

Got it. So if one has $45,000 of non-deductible value in an IRA, with $35,000 in basis, he can add $5000 on 1/1/10, do the conversion 1/2/10, and pay taxes on the total $10,000 in gain in years 2011 and 2012, meaning tax on $5000 owed 4/15/12, and tax on $5000 owed 4/15/13. Right? What a steal!

That's only accurate if that person has no other IRAs.

Assuming we are not "subject to backup withholding", can we delay paying the tax until 4/15/12 and 4/15/13 without penalty? Does the government charge interest and penalties by default?

I think it should also be noted that for many who are considering all of this (such as myself), the top marginal tax rate is likely to rise after 2011. Again, I still think this conversion makes sense, but it is important to note that the conversion, especially if one has significant pre-tax IRA funds that will be included in the basis, will be slightly more expensive given the likely bump in the top marginal rate as the Bush tax cuts sunset.

I'm interested in finding out what strategies folks have for rolling their pre tax IRAs into 'shell' self-employed 401ks so that they don't have to include the pre tax IRAs in their basis, and thus get dinged with a potentially large tax liability (though this may still be advisable -if you can predict the future)...

This assumes that your current 401k does not allow you to 'roll in' assets from a preexisting pre-tax IRA...

What ? I thought you had to pay taxes on the full value of the converted IRA, so in this example, you would owe tax on the full $45,000 when you convert your traditional (non-deductible) IRA to a Roth IRA. I'm not sure if it matter what part of this amount is the basis and what part is gains - you pay tax on the whole amount. Is that right ?

A traditional IRA and non-deductible IRA are not synonymous terms. There is no such thing as a non-deductible IRA. A traditional IRA can be funded with deductible contributions and/or non-deductible contributions.

If one has IRAs that have only had non-deductible contributions (post tax), only the gains will be taxed because the contributions have already been taxed. Ex. $35,000 of contributions and $10,000 of gains. Only the $10,000 will be taxed. If instead, the contributions were all deductible (pretax), the entire amount will be taxed at conversion.

It gets confusing for people who have both pre-tax and post-tax contributions. One can't pick and choose what to convert. From an IRS standpoint, it will be treated as one IRA.

Thanks to the OP and LH2004, great info so far =D

I'm just now learning about my employer's 403B plan, which is a tax-advantaged retirement savings plan similar to a 401K. Apparently having a 403B precludes me from participating in a tax-deducted tIRA (my income does not). Can 403B's - or for that matter the more standard 401k - be rolled over into a ROTH in 2010 in order to defer some

XrayTed said: Thanks to the OP and LH2004, great info so far =D

I'm just now learning about my employer's 403B plan, which is a tax-advantaged retirement savings plan similar to a 401K. Apparently having a 403B precludes me from participating in a tax-deducted tIRA (my income does not). Can 403B's - or for that matter the more standard 401k - be rolled over into a ROTH in 2010 in order to defer some

this strategy only makes sense if your income precludes you from participating in a Roth IRA. Since yours doesn't, why not just make the contribution to a Roth from the outset and be done with it?

I believe the answer to your question is: You first have to rollover the 403b into a traditional IRA; then you have to convert the IRA to a Roth. I don't think you can do the rollover while still employed at your company.

XrayTed said: I'm just now learning about my employer's 403B plan, which is a tax-advantaged retirement savings plan similar to a 401K. Apparently having a 403B precludes me from participating in a tax-deducted tIRA (my income does not).Income alone never prevents a traditional IRA deduction. You can deduct a contribution unless both (1) you actively participate in an employer plan (including a 403(b), a 401(k), a defined benefit pension plan or any of the other kinds of tax-advantaged plans through an employer), or your spouse does, and (2) your income is over the limits.

psychtobe said: Can 403B's - or for that matter the more standard 401k - be rolled over into a ROTH in 2010 in order to defer somethis strategy only makes sense if your income precludes you from participating in a Roth IRA. Since yours doesn't, why not just make the contribution to a Roth from the outset and be done with it?Well, it does have the advantage of getting the extra ~1.5 years of tax deferral due to the special 2010 rule. That's not worth a ton at today's interest rates, so I wouldn't go to huge trouble to get it, but it's something.

Normally, with any kind of deductible or Roth IRA (or 401(k), etc.), the present value of the taxable income you (or your heirs) will eventually have equals the value of the contribution (as of its year). With a Roth IRA, you pay the tax in the year of the contribution, on the amount contributed; with a traditional IRA that you leave alone, you pay it on the amount withdrawn, which is the future value of the contribution, but in the year of the withdrawal; with a traditional IRA that you convert, you pay it on the amount converted, which is the future value of the contribution to the year of conversion, in the year of conversion. You always have matching like that, which is why Roth and deductible contributions are equally good if tax rates stay constant the whole time. With a 2010 conversion, it's just like you converted half of your IRA in 2011 and half in 2012 -- but your taxable income is based on the value in 2010, not in those years, so you're never paying tax, even in NPV, on the growth between 2010 and 2011-12.

I believe the answer to your question is: You first have to rollover the 403b into a traditional IRA; then you have to convert the IRA to a Roth. I don't think you can do the rollover while still employed at your company.You can roll over directly to a Roth IRA in any situation where you can roll over to a traditional IRA (which is, basically, any withdrawal from a qualified plan other than a hardship withdrawal, substantially equal periodic payments, and deemed payments like when you don't repay a loan). The problem is, you usually can't withdraw your contributions while you're still employed with the plan sponsor, if you're under 59 1/2. I don't understand all of the rules on 403(b)'s, so it's possible that the particular plan would allow withdrawals more easily, but most of them don't. Still, it could make sense to plan on it if, say, you were confident that you would be quitting the job by 2010.

Mine is an s-corp, the wife's is an llc w/ s-corp elections (so basically an s-corp).

What I was thinking exactly is not so much as to boost retirement contributions, as they're already several thousand/mo so I don't want to get any more carried away with our retirement portfolio's, but instead just literally lowering my income. Taking smaller paycheck's, and for those paycheck's pay myself mostly AAA Distributions because at year end, I will Section 179 all of that down (I'll keep running the numbers throughout the year to know how much equipment I can do that with) with new equipment purchases. Normally I keep 51% payroll / 49% distributions but since I'll S179 it, that allows me to pay myself that way more without fear of restructuring (sound correct? my accountant let me do it before).

For payroll income, that could be deducted enough with donations, mortgage interest, property taxes, state/local taxes, and of course my normal amount of solo 401k contributions (since I'll effectively lower my pay in 2010, solo 401k would be better to contribute that year since the cap will be more!).

Then to help the s-corp, I'll do the capital improvements to my home and build the lab I've been waiting for, as well as purchase any other additional equipment (even on 0% credit if needed) to keep the numbers down.

If all goes well, that should have me down into the 15% bracket no problem. The one question I have is though, is converting to a ROTH just making that amount (let's say I do $60K) taxable at that 15% rate? Or because $60K of additional income is enough to bump me up to the next bracket would I be now paying 25% on all the income, including the conversion? That's the one thing I wasn't sure of...

DavidScubadiver said: My IRA has a non-deductible contribution basis of 24,000 and a value of 27,000.
I believe that means the only tax I have to pay on the conversion is the non-deductible contribution made when I opened the account in 1993 or 1994, since, as of now, that contribution means I am essentially flat on the capital gains portion.

I hope I have something tat shows when I opened this account....

If you convert the entire thing, you will only pay tax on the $3,000 gain. This assumes that you don't have any other IRAs.

ilikebtmoney said: What I was thinking exactly is not so much as to boost retirement contributions, as they're already several thousand/mo so I don't want to get any more carried away with our retirement portfolio's, but instead just literally lowering my income. Taking smaller paycheck's, and for those paycheck's pay myself mostly AAA Distributions because at year end, I will Section 179 all of that down (I'll keep running the numbers throughout the year to know how much equipment I can do that with) with new equipment purchases. Normally I keep 51% payroll / 49% distributions but since I'll S179 it, that allows me to pay myself that way more without fear of restructuring (sound correct? my accountant let me do it before).OK. That's a very specific strategy: you're intentionally increasing your corporation's income in order to increase the sec. 179 limit under sec. 179(b)(3). It sounds like it may make sense for you, but only because you're in that situation (and otherwise would be exceeding the limit). In general, having your S corporation cut your paycheck would have no net effect on your taxable income: it would decrease your entry for wages, but increase the corporation's income by the same amount, which flows through to the Schedule K-1 it gives you and then onto your personal return. It would save you some payroll tax, but that's usually a smaller concern than income tax.

If all goes well, that should have me down into the 15% bracket no problem. The one question I have is though, is converting to a ROTH just making that amount (let's say I do $60K) taxable at that 15% rate? Or because $60K of additional income is enough to bump me up to the next bracket would I be now paying 25% on all the income, including the conversion? That's the one thing I wasn't sure of...Income from a conversion is taxed the same as interest, wages or any other ordinary income (except for the special 2010 spread-out rule). This year, for singles, the 15% bracket goes up to $33,950 of taxable income, then the 25% bracket is up to $82,250. If you had other income of $30,000, and then added $60,000 from a conversion, that's taxed the same as anybody else with $90,000 of taxable income: the last $7750 is going to be in the 28% bracket.

azygous said: LH2004 : Looks good. You may want to consider continuing to contribute to traditional IRA's in 2011 and beyond, and immediately converting those, too.
--But my HHI after 2012 will increase alot and not sure how that will help me...OK. In that case, through 2012, you want to get as much as possible into Roth IRA's, either by direct contributions (if you qualify) or by contributing to a traditional IRA and converting. After your income goes up, you will want to use whatever employer plans you have, but if you have plenty of income available to save, you will be wanting to contribute to traditional IRA's and immediately to convert.

This is slightly off topic, but all this clamoring to get into Roth IRAs makes me wonder what the probability that the US tax structure changes to a lower income tax and more of a consumption tax (i.e. VAT tax). Won't this severely decrease the value of having funds in a Roth? This doesn't seem to be taken into account in the decision making process here and most young people assume that the Roth is a no brainer.

I realize this is a slim possibility, but a lot of things have happened these past 6-9 months that have been a slim possibility in my book.

What do you think?

all true, but I think it would be very hard to have the fundamental feature of the Roth (tax-free withdrawals) changed without massive public opposition. I know some others are more pessimistic than me, but I do not think this will happen. On the margin, some of the benefits you mention could change. I also don't see income tax being replaced by a VAT - we need all our current revenue and then some. What would happen is a VAT added to current income tax. In that case, a Roth still maintains its advantages.

quarterstock said: I'd like to expand on psychtobe's original question:

Can I do the following:
1) Deposit $10k in a traditional IRA on January 1, 2010
2) Transfer the same $10k to a Roth-IRA on January 2, 2010
3) Characterize $5k as a nondeductible contribution for 2009, and save the other $5k for a 2010 nondeductible contribution on form 8606.

Secondly, is the Roth conversion income-limit provision only lifted for 2010 or has it been lifted for 2010 AND EVERY year thereafter?

1) Yes, assuming that your IRA custodian is open on January 1. However, you must notify them at the time you make the deposit that $5,000 is for 2009 and $5000 is for 2010.
2) Yes, assuming there is no hold on your deposit. You may have to wait for your check to clear.
3) You will have to file Form 8606 for both 2009 and again for 2010 if you want both contributions to be treated as non-deductible.

You actually do not have to wait until Jan 1, 2010 to make your 2009 traditional IRA contribution. You can convert any and all balances in your traditional IRAs to Roth IRAs starting in 2010 whether the deposits were made in 2010 or earlier.

Secondly, the income limit has been removed permanently. (However, Congress may always amend the law at a later date if it decides to.) The one feature that is unique to 2010 only is the option to spread out the taxes on the conversion over the following two years.

The restriction on people over age 70 1/2 making traditional IRA contributions has not been removed. So if a person over age 70 1/2 has too high an income to make a Roth contribution directly, they will not be able to circumvent the limit by making a traditional IRA contribution and then converting it.

Thanks for the quick responses.

I'm well aware of the pro-rata rules for transferring deductible and nondeductible contributions from a TIRA to an Roth IRA. I don't currently have any TIRA's -- only a 401k and a smallish Roth IRA that's been languishing since my income started exceeding the ceiling years ago.

So I'll have to first establish a TIRA on the hypothethical Jan. 1 date before it can be funded and rolled to a Roth on January 2nd. No problems there.

I'm new to the form 8606 though. Under what circumstances am I required to file this form each year? Is it only the years that I make non-deductible contributions to an IRA? What about years where there are withdrawals from the same IRA?

almost certainly not, but what does your state say? you also may want to consult your crystal ball to tell the future a little better.