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March 18, 2010


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Roth Conversions are a neat little trick for the government to get a bump in revenues short-term. Doing the conversion only makes sense if your current tax rate is lower that you expect your tax rate to be in retirement. They are going to get their taxes out of you one way or the other.

You also have to have a strong belief that the government will not change the rules on Roth IRAs no matter how desperate their financial situation gets in the future.

I agree that you need to know that your tax bracket will be substantially lower in retirement. Also, it is best if you are sure your bracket over 2011 and 2012 won't increase. Otherwise, you may pay a much higher tax than if you paid the tax in whole in 2010. Finally, if you plan to donate a substantial portion of your IRA to charity upon death, it may not be a good idea to convert.

I do concur that you should create a converted Roth for each asset class just so you can be sure that you can recharacterize if the asset class loses value between now and October 2011.

Quick question. If you make too much to deduct for a tradition IRA, there is absolutely no reason not to start a non-deductable IRA and then immediately convert it to a Roth-IRA. You have to pay taxes on the value anyway, right?

@Texas Wahoo.

That is exactly right. Everyone can either contribute to a Roth and do the non-deductible conversion you mention. And everyone should do one or the other of those. That is a no cost way of getting money into a Roth. Converting existing deductible traditional IRAs is a little more dicey.

I have heard these segmented Roth conversion strategies many times before. On the whole the advice given is sound with respect to the different options and re-characterizations.

It's a big hassle what he proposes and if you have significant money available to do this game with it might be worth that hassle. But just know the mess you are potentially creating for yourself to deal with this. It might be best to get professional help because if you do these re-characterizations wrong, the penalties could be very very painful.

Texas Wahoo and Apex --

I have made non-deductible IRA contributions for a few years and I had hoped I could simply convert those funds (co-mingled with deductible funds from earlier years) to a Roth and pay no taxes. However when I was working through a Vanguard spreadsheet, the form told me that I could not simply convert the non-deductible contributions -- that I had to convert both deductible and non-deductible funds on a pro-rated basis.

I didn't investigate the issue further and maybe I misunderstood, but you may want to look into it a bit more if you're thinking of using this strategy.


You are correct. You cannot "deem" funds segmented after the fact. This strategy only works on segmented funds. The best way is to have a separate IRA for non-deductible contributions and do not mingle them with any previous deductible contributions. Of course any gains will be tax deferred and so those are co-mingled with non-deductible funds and you would have to pay tax on the gains but if the funds were contributed recently the gains will be small and if the funds were contributed anytime in the last 10 years there likely are no gains. :(

So if you co-mingled deductible and non-deductible contributions in the past then yes, unfortunately that does not help you. Going forward, I would suggest a separate account for non-deductible contributions and then convert them as soon after the contribution as allowed (and I don't know if there is a required waiting period or not).

As you can see this new conversion law makes the Roth IRA contribution income caps obsolete but instead of repealing them the just leave in place this arcane method of making a non-deductible contribution and then converting it. And I bet it stays that way for a long time because where is the govt incentive to remove the extra wasted effort?


As a side note to your issue. If you have not made a 2009 non-deductible IRA contribution yet you should do it in a separate non-deductible only account prior to April 15. If you haven't made a 2010 contribution yet you should do the same with that anytime this year. If you have already made both of those contributions then you have no choice but to wait for 2011 to do any non-deductible contribute and convert strategies.

FMF & Apex: Ask for suggestion

I am a faithful reader of this blog. Now I have a question about using non-deductible IRA and converting to Roth IRA and I wonder if you could share your insight on this.

My current financial situation: my family income exceeds the Roth IRA limit for the recent two years. Besides maximizing 401K, we decide to put after-tax money in the company provided saving account, which offers a few index fund choices with very low fees (almost nil). This after tax contribution will be tax free upon withdraw, while its gain will be tax-deferred until withdraw.

I just realized we actually have the option to open a traditional IRA account with after tax money, then immediately convert it to Roth IRA in 2010. Now I am considering this option. This should be a more preferred choice than putting money in the after-tax account with only tax-deferred benefits, right? The only gain I see in that approach is the very low administration fee.

Also, if I still want to catch the 2009 IRA contribution this way but I have already filed the 2009 return, what should I keep in mind during the conversion and tax report?

Could you kindly lend your opinion on this?

Can I do a Roth recharacterization even if I had activitiy in the account after the initial conversion? Example: convert $1000 cash from a Traditional IRA to Roth, buy stock A in Roth, stock A drops in value 50%, then recharacterize?

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