| Sargent & Lundy Savings Investment Plan |
| ROTH IRA CONVERSIONS: IT'S MORE COMPLICATED THAN YOU THINK |
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The following excerpts are from a recent article in
The Wall Street Journal. The opinions of the author, Kelly Green, may or
may not reflect those of the SIP Committee. Please seek tax advice before
making any decisions. Q. My wife and I have been unable to contribute to Roth IRAs for the past several years due to the income limits. We have Roth IRAs from years that we were eligible, and we both have rolled over 401(k)s from previous employers to IRAs. I was planning to take advantage of the back door into the Roth IRA for people like ourselves. We were going to fund after-tax IRAs for 2009 and 2010 this month, and then convert them to Roth IRAs, which we had hoped would be tax-free, since all of the money converted would be after-tax money. However, I read in a Wall Street Journal article that you can't convert only your nondeductible contributions. You have to calculate your "basis" and deduct that portion. Are my rollover IRAs from previous 401(k) plans considered part of my total balance in IRAs? Or can I only count the traditional IRAs that I'm converting as my IRA balance? A, Individual retirement accounts funded with 401(k) assets count among your traditional IRA assets during a Roth IRA conversion. The language is confusing, since many custodians refer to such accounts as rollover IRAs. But they are technically traditional IRAs. Any IRA labeled as a SEP, SIMPLE or contributory is included, as well. As of January 1, 2010, the federal government has lifted the $100,000 household income limit (modified adjusted gross income) on converting traditional IRA assets to a Roth. Having that limit removed makes it possible for people to move assets from traditional IRAs to Roth IRAs. But people who have rollover IRAs from past employment will have to include those assets when they figure out how much tax they owe on such a conversion. You can convert all, or part of, your traditional IRA assets to a Roth, but you owe tax proportionately on the amount that wasn't taxed previously. That is where the Internal Revenue Service's pro rata rule comes into play. Basically, you can't cherry-pick the assets you convert. Instead, the IRS says you must first take the balance in your IRA, or the combined balances of multiple IRAs, and then divide any nondeductible contributions by that balance. This gives you the percentage of any conversion that is tax-free. Let's say your rollover IRA has a balance of $23,000, and the new IRAs you fund are worth $13,000, including $12,000 in non-deductible contributions. You would divide $12,000 by $36,000, to find that 33% of your conversion would be tax-free. There is one possible way around the tax. If your current employer has a retirement plan, you may be able to roll the pretax assets from your rollover IRA into it, leaving only your nondeductible contributions subject to the pro rata rule. Remember, the pro rata rule is tied, in large part, to the balance of all your IRAs (except for Roth and inherited IRAs). So, the smaller the proportion of tax-deferred assets and earnings in the accounts, the more money you can convert tax-free. And some company retirement plans do let participants roll assets from an IRA back into a 401(k). The key: Assets in a 401(k) or similar retirement plan aren't included in pro rata calculations. |
This page updated on 1/19/2010