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

Undoubtedly, the Roth IRA has some subtantial 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, nondeductible contributions, and earnings, the rules of conversions are more complex. It would be fantastic if the nondeductible 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 nondeductible contributions.

John Doe, a 30% taxpayer, has a traditional IRA worth $200,000 on Dec. 31, 2020, of which$100,000 is nondeductible contributions. Doe wants to convert $100,000 of this IRA to a Roth. Because Doe has$100,000 of non-deductible contributions in this traditional IRA, the assumption might be that he could convert the 100,000 of nondeductible 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 nondeductible contributions can be singled out and converted tax-free. Another misconception is that the nondeductible 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.