How to Convert a Nondeductible IRA to a Roth IRA

If you have a nondeductible IRA, you can convert it into a Roth IRA and enjoy the Roth’s additional advantages, including tax-free withdrawals and no required minimum distributions (RMDs).

However, the rules you’ll need to follow will depend on whether you have only nondeductible IRAs or both nondeductible and deductible IRAs.

Key Takeaways

• Nondeductible IRAs work like other traditional IRAs except that you don’t get any tax deduction for your contributions.
• Because your contributions have already been taxed, you won’t have to pay taxes on them again when you convert your nondeductible IRA into a Roth IRA.
• Your account’s earnings, however, will be taxable at the time of conversion.
• If you have both nondeductible and deductible IRAs, you will have to add them all together and prorate the amounts to determine how much of your conversion is taxable and how much is tax-free.

Nondeductible vs. Deductible IRAs

Nondeductible and deductible IRAs are both traditional individual retirement accounts (IRAs), with one key difference: With a nondeductible IRA, you don’t get a tax deduction for the money you contribute, but your account will grow tax-deferred until you make withdrawals. At that point, your withdrawals will be taxed as income.

People who contribute to a nondeductible IRA often do so because their income is too high for them to contribute to a Roth IRA or to deduct their contributions to a traditional IRA.

The deductible traditional IRA is the more common type. It provides a tax deduction at the time you make your contributions, subject to certain income limits. As with a nondeductible IRA, your contributions will grow tax-deferred and be taxed only as you withdraw the money.

Both nondeductible and deductible IRAs are subject to required minimum distributions, starting at age 73. The age has been bumped upwards a couple of times but it’s set at 73 as of Jan. 1, 2023.

Note

At one time, taxpayers with incomes above $100,000 were ineligible to make Roth IRA conversions. However Congress removed that restriction as of 2010, and now everyone is eligible.

If All of Your IRAs Are Nondeductible IRAs

If your IRA savings are composed entirely of nondeductible IRAs, you can convert them to a Roth IRA relatively simply. You won’t have to pay tax on your contributions to the account (which have already been taxed), but you will owe tax on the account’s earnings.

For example, Susan Smith is in the 24% tax bracket this year, and she only has one IRA, worth $100,000. The IRA is composed of $60,000 in nondeductible contributions and $40,000 in earnings. If she decides to convert the entire IRA to a Roth, she would only have to pay taxes on the earnings portion ($40,000). At a 24% tax rate, it would cost her $9,600 in taxes to convert the entire $100,000 to a Roth.

If You Have Both Nondeductible and Deductible IRAs

If you have both types of traditional IRA, making a conversion is more complicated. Unfortunately, you can’t simply convert your nondeductible IRAs. Instead, you must treat all of your IRAs (of both types) as if they were one big IRA. Then you must prorate the amount of money you convert based on the proportion of nondeductible versus deductible funds in your total IRA.

IRS Form 8606, which you use to report the transaction, will walk you through the steps. There are also calculators available online.

As an example, suppose Sam Smith has IRAs totaling $200,000 and wants to convert $100,000 of that into a Roth IRA. His “basis” (the amount he has already paid taxes on through his nondeductible IRA contributions over the years) is $20,000.

Sam’s basis of $20,000 represents 10% of his total IRA balance ($200,000). So 10% of the $100,000 he is converting into a Roth would be tax-free, while the remaining 90% would be taxable.

If Sam is in the 24% tax bracket, the conversion would cost him $21,600. Actually, it would cost him at least that amount. Depending on Sam’s other income, and how close he is to the top of the 24% bracket, some of it might fall into the next highest bracket and be taxed at 32%.

That is why anyone who is thinking of converting a significant sum should consider their current tax bracket and possibly spread the conversion over several years to minimize the tax hit.

How to Complete the Conversion

You have several options for executing the conversion. The easiest—and usually the safest—is to instruct the financial institution where your IRAs are currently held to transfer the money into a Roth account either at that financial institution or a different one.

This is known as a trustee-to-trustee or same-trustee transfer. If you’re changing trustees, your current trustee may issue you a check made out to the new trustee for you to deposit.

Are There Limits on How Much Money You Can Convert Into a Roth IRA?

No, you can convert all or part of the money in your traditional IRAs into a Roth IRA. Bear in mind, however, that if you plan to convert a large sum, spreading your conversions over several years could possibly lessen the tax bill.

When Are Roth IRA Withdrawals Tax-Free?

Withdrawals of Roth IRA earnings are tax-free if you’ve had a Roth account for at least five years and are either 59½ or older or qualify for an exception. You can withdraw contributions tax-free at any time.

What Is a Backdoor Roth IRA?

A backdoor Roth IRA refers to a two-step maneuver that people with high incomes can use to get around the income limits on Roth IRAs. First, they contribute to a traditional IRA (which has no income limits), then they convert that IRA into a Roth.

The Bottom Line

If you have a nondeductible IRA, you can convert it into Roth IRA. You won’t have to pay tax on your contributions to the account, but the account’s earnings will be taxable at the time of the conversion. If you have both nondeductible and deductible IRAs, you’re required to prorate the taxable and nontaxable portions to determine how much of your conversion is subject to taxes.

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