IRA conversion when part of the contributions were non-deductible. Taxes owed?

Question

I have a traditional IRA, which has money which has been contributed three different ways:

1. deductible IRA contributions
2. non-deductible IRA contributions
3. rollover from 401(k)

I'm looking at converting this to a Roth IRA in 2010, now that there's no income limitation. I also may only convert part of my traditional IRA this year, to avoid a bump in the marginal tax rate.

I also have a Roth 401(k), although I don't think this has any effect.

How would the calculations work for how much tax I would owe? Are there any other things I should be aware of?

Answer 1

Conversions are done on a pro-rata basis. If you haven't yet paid tax on the money, you need to do so in the process of converting.

Let's say you have a total of $50k in your account:

• $10k in deductible contributions
• $10k in non-deductible contributions
• $20k in 401(k) rollover funds
• $10k in as-yet untaxed earnings

If you decide to convert half of this to a Roth ($25k), you'd owe tax on $20k of that, because 80% of your holdings in the traditional IRA have not been taxed yet. The non-deductible contributions have been taxed, so you don't need to pay tax again on that part.

More information is here.

Answer 2

MB's math is right, but I can describe it in a short sentence. All Traditional accounts are combined, 401(k) rollover is no different from other IRA money. You should have been tracking your non-deducted money via form 8606 so you know this figure. The non-deducted money as a percent of your total balance is the percent of conversion that's not taxed. (To be clear, deducted contributions and growth are not tracked separately, one only tracks the non-deducted deposits.)