## Converting a Non-Deductable IRA to a Roth IRA

Undoubtedly, the Roth IRA has some substantial advantages over a traditional IRA. For example, the Roth IRA offers tax-free withdrawals of contributions and earnings upon retirement, and the required minimum distribution (RMD) is not applicable.﻿﻿ Fortunately, traditional IRAs can be converted to Roth IRAs.

## Where It Gets Tricky

For an IRA that contains normal contributions, non-deductible contributions, and earnings, the rules of conversions are more complex.﻿﻿ It would be fantastic if the non-deductible contributions could be singled out and only that portion be converted to the Roth tax-free. However, IRS rules prevent this strategy. Here is a look at the special tax treatment of partial conversions for owners with multiple IRA accounts or IRAs with both deductible and non-deductible contributions.

John Doe, a 30% taxpayer, has a traditional IRA worth $200,000 on Dec. 31, 2020, of which$100,000 is non-deductible contributions. John wants to convert $100,000 of this IRA to a Roth. Because he has$100,000 of non-deductible contributions in this traditional IRA, the assumption might be that he could convert the 100,000 of non-deductible contributions tax-free. Unfortunately, the IRS has a special formula that must be followed for an IRA with normal contributions. Here's how it works: ﻿\begin{aligned} &\textit{Tax-Free Percentage}=\dfrac{TND}{(YV + C)}\\ &\textbf{where:}\\ &TND = \text{Total non-deductible contributions}\\ &YV = \text{Sum of year end value of all IRA accounts}\\ &C=\text{Conversion amount}\\ \end{aligned}﻿ Thus, given the example above, John Doe would calculate the following: ﻿\begin{aligned} &\text{\100,000}\ \div\ (\text{\200,000}\ +\ \text{\100,000})=\\ &\text{\100,000}\ \div\ \text{\300,000}\\ &\text{Tax-Free Amount of Conversion}\ = \ 33\% \ (\text{or }\text{\33,333}) \end{aligned}﻿ Therefore, if John converts100,000 to the Roth, he will have $33,333 ($100,000 x 33.3%) that is not taxed and $66,667 ($100,000 x 66.7%) that will be taxed at his 30% tax rate.

## The Bottom Line

The common misconception is that the non-deductible contributions can be singled out and converted tax-free. Another misconception is that the non-deductible contributions are simply divided by the total value of the IRAs to determine the tax-exempt amount percentage. However, the formula is a little more complex. Understanding the rules will keep the IRS at bay. Consult with your tax professional to ensure that the appropriate forms are filed, and the calculations are accurate.