Broker Check

Clearing Up What Happens When Converting Between Traditional and Roth IRAs

Howard Hook CFP®, CPA, quoted in The Star Ledger's business column, "Biz Brain" on April 15, 2012

Question: I converted a traditional IRA to a Roth IRA in 2011 and I am not eligible to contribute to a Roth IRA for 2011. An earlier Ask The Biz Brain column said I should be able to open a non-deductible IRA account and immediately convert it to Roth IRA. It sounds too good to be true. Can we do this every year, and would I have to pay taxes on the contribution? And after a conversion to a Roth, do I need to close the traditional IRA account? And finally, can I distribute the 2011 traditional to Roth conversion tax burden (my earlier 2011 conversion) over two years, for 2011 and 2012? – AK

Answer: That which sounds too good to be true usually is, but not in this case. Call it a loophole, and you can do it each and every year. Roth IRA contributions are subject to phase-outs based on your modified adjusted gross income, and if you earn too much, you can't contribute to a Roth at all, said Gail Rosen, a Martinsville-based certified public accountant. “For high-income taxpayers, this can reduce or completely eliminate the amount an individual can contribute to a Roth IRA once their income exceeds $169,000 for those married filing jointly, or $107,000 for singles,” Rosen said.

But you still have the traditional option. To make the roundabout Roth contribution, you would first make a non-deductible traditional IRA contribution. You can then immediately transfer that contribution to a Roth IRA, no questions asked. If you make the move from traditional to Roth quickly, you probably won't owe any taxes. The only taxes you'd owe would be on any earnings in the account. If you convert quickly, the account won't have much time, if any, to earn anything, said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton. Hook said you can keep the traditional IRA account open after you make the conversion, but you'll also need to file Form 8606, which shows the conversion.

As far as distributing any tax burden over two years, that's not an option. “If you mean spreading the tax over two years for your 2011 conversion, the answer is no,” Hook said. “That was only available for 2010 conversions.” You still have a couple of days to make this happen before the April 17 tax filing deadline. Before you make the move, speak to your brokerage house and make sure the conversion can happen fast enough for you to submit the proper paperwork with your return.