Taxes 101: IRA Conversions

IRAs are all the rage during tax season. In fact, 82 percent of taxpayers qualify for tax-deductible IRA. To understand the Roth IRA, we need to take a tiny step back and first get to know the Traditional IRA. The Traditional IRA allowed you to reduce your taxable income by making a deposit to your IRA and taking that amount as a deduction off your income for tax purposes. For those in the 25% tax bracket this means that a deposit of $5000 is only $3750 out of your pocket this year. If you have a 401(k) or similar retirement plan at work, your ability to deduct you IRA deposit may be limited depending on your income. This phase-out begins at $55,000 for singles, $89,000 for married. Here’s a short video and post about boosting your refund with IRAs.

On the withdrawal side, you may not withdraw funds prior to 59-1/2 (with limited exceptions) and at age 70-1/2 you are required to start taking withdrawals based on your life expectancy, otherwise known as RMDs, required minimum distributions. The withdrawals are taxed as regular income and subject to whatever marginal rate you’re in when you take that money. The benefit of this is that many people expect to be in a lower tax bracket upon retiring than when they were working.

Now, let’s look at the Roth IRA. In a sense, it’s the opposite of the Traditional IRA. You get no tax deduction for deposits, but the money can grow and is withdrawn tax-free. The money you deposit can be withdrawn at any time without penalty, but the growth within the account is not taxed if withdrawn after 59-1/2.

There are no required distributions at any age. The Roth IRA has its own income limits if you are covered by a plan at work, the phase-out begins at $105,000 for single, $167,000 for married.

So far, we’ve reviewed how to deposit to either account. One other possibility is to convert money from your Traditional to your Roth IRA. You would be required to pay the tax on the converted amount, but that money, as part of the Roth IRAs would not be subject to tax again. Until this year, the conversion was only allowed for people whose adjusted gross income (AGI) was under $100,000. Starting this year, anyone is permitted to convert. A special rule is in place for conversions made in 2010. You are permitted to take the converted amount and pay the tax on half the conversion in each of tax years 2011 and 2012, adding no income to the 2010 return. The current law also permits a conversion from your 401(k) directly to a Roth account, no need to first move it to a Traditional IRA.

These are the basics for what these accounts are and the tax implications for each, but how do you decide which one is right for you and whether or not a conversion from you Traditional IRA or 401(k) to a Roth IRA is the right move? First, you must know your marginal tax rate which is the tax paid as a percent of the very next dollar of taxable income. Unless you are near retirement or already there, your marginal rate at retirement is a bit of a long term forecast. Keep in mind, however, in today’s dollars a single retiree can have $43,300 in gross income (with exemption and standard deduction totaling $9,350 this is $33,950 taxable) to be at the top of the 15% bracket. It would take over a million dollars in pre tax accounts to create income this high. So, as a first step, it’s not a bad idea for someone in the 10% or 15% bracket to choose Roth knowing that as their income increases, they may wish to move to the pre tax 401(k) or IRA to avoid taxation at 25%.

An older wage earner may find that their pension will provide such high replacement income that when combined with their own retirement account withdrawals, they will be in a higher bracket at retirement. Using Roths and starting to convert their pre tax accounts a bit at a time can be a good idea. If you decide to convert, remember, it’s wise to do this only if you can pay the tax, when due, from other funds, not from the IRA money.

As with any financial issue, your specific situation will differ from those of others, so an understanding of the tax consequences of any decision you make is important. If you have questions after reading this, feel free to ask here, there are many who are happy to help. Hopefully now you see why 85 percent of IRAs are opened during tax season.

Comments (32) Leave your comment

  1. Turbo tax is counting my Roth conversion amount as “excludable” from my Hawaii state tax. Is that correct? (Converting from Traditional to Roth in 2010, paying in 2011 and 2012)

  2. Does Turbo Tax software contain the form and instructions for taking the minimum required distribution from an IRA after age 70-1/2? I understand this is IRS form 8606. Am I correct?

    • Hi Chuck,
      Yes TurboTax handles form 8606 and your distributions would be included on your form 1099-R
      Thank you,
      Lisa Greene-Lewis

  3. Having the same issues as most of these posts! Bummed that there isn’t a fix for this issue – have to file an extension & do taxes the “old-fashioned” way. I guess the goods news is we all know enough check and challenge the SW. I’m thinking TT lost my future business too!

  4. The problem with the 2010 Trad to Roth conversion certainly gave me a lot of headache/hassle. I believe the ‘bug’ we are experiencing in TT is leftover data if you mistakenly check the Roth IRA contribution but then do not delete the form! I know I made a mistake the first time I was doing the program, but after doing some internet searching, I believed the problem is solved by going to FORMS mode and DELETING (I think TT calls it removing) the IRA Worksheet Form.

    When I re-did it after that, TT correctly showed me I have exceeded my income cap for traditional IRA contribution and cannot deduct it. I have the conversion correctly entered under the 1099-R section.

  5. An update:

    Although I had looked at IRS Publication 590 previously when researching this issue, I just revisited that document and found some examples that I didn’t see on the first reading.

    It appears that TurboTax is handling the issue in accordance with IRS Publication 590’s example. The example I am referring to is on pages 40 & 41 and involves “Rose Green”.

    Unfortunately when I researched this in late 2009, I didn’t find any indication that multiple Traditional IRA’s would be treated as a single entity for the purpose of determining the basis for a conversion.

    Scott

  6. I just got off the phone with TurboTax support. What an outstanding experience – Hat’s off to Julie!

    That’s the good news – the bad news is TurboTax, at this time, isn’t able to handle my situation.

    Here’s my scenario:

    I have been working for over 30 years.

    I have always been a part of a Employer Provided Retirement Plan.

    I have been making yearly (non-deductable) contributions to Tradtional IRA’s for my entire working life.

    I am unable to make a contribution to a Roth IRA because I make too much money.

    In 2010 I opened a completely new Traditional IRA

    account and contributed $6000.00 to this account. Again, as in the past, this is a non-deductable contribution.

    About a week later I converted the money in that account to a Roth IRA account. The amount of money converted was $6000.05.

    Based upon my understanding of the law, I believe that the above should be treated as a zero-gain (OK – 5 cent gain) Traditional IRA to Roth IRA conversion.

    The above is the scenario: Here’s what TurboTax-Customer-Support-Julie & I determined.

    TurboTax takes ALL of my Traditional IRA accounts and lumps them together. It then takes the basis of ALL these accounts and calculates a taxable event based on that historical basis. The way TurboTax handles this situation, this is a taxable event because the gain isn’t 5 cents but is proportionally based on the gains received over 30 years of having Tradtional IRA’s.

    As far as TurboTax-Customer-Service-Julie and I can tell, TurboTax is unable to break out my “2010 Only” IRA account’s basis seperately and treat this Roth conversion as a zero-gain event.

    I researched my “individual 2010 contribution” Traditional IRA account to Roth IRA conversion strategy at some length before executing this tactic. I am pretty confident that what I did should be a Zero-Gain Tax Event.

    If I am correct, when will TurboTax offer a path to calculate this sort of event as a Zero-Gain Tax Event?

  7. So TurboTax Deluxe does not add income from Roth IRA conversion from Regular IRA anywhere on Form 1040. I did a complete conversion of a whole account and checked that box in TurboTax(R). Also have a 2 in box 7 of 1099R. Taxes due in 2 weeks, when will this BUG be fixed??????

  8. I ran into the same problem. I converted a traditional ira to a Roth, but TT keeps saying I have exceeded the income limits.

    I tried switching to HR Block online and it has the same problem!

    Has anyone tried any other tax prep websites that correctly account for Roth conversions?

  9. All,

    I think in TT the question if you recharcterized may be the problem. My interpretation is recharacterization and conversion are two different things. I was also getting told I would pay a penalty until I said nothing was being recharacterized.

  10. TT is not handling the non-deductible traditional IRA to Roth IRA conversion correctly. No matter what we do, it seems to consider the non-deductible contributions as taxable.

    Bob Meighan, when can we expect a TT update to fix the bug?

  11. Simon S:

    With the 2010 Roth IRA conversion the

    50% split means split between *tax years* 2010 and 2011. Nothing is due on the year 2010 form I believe. Read IRS pub 590 for the definitive information.

  12. TurboTax Deluxe definitely has a bug in not transferring the correct taxable amount as income to line 15(b) of Form 1040.

    ATTN: Bob Meighan, VP TurboTax, who wrote on Mar 7, please help

    I downloaded a 1099-R on Roth IRA conversion into TurboTax. After doing the TurboTax interview for the 1099-R, I opened Form 8606-S which shows that the correct taxable amount is actually calculated there. The default case is to split the taxable amount into two, 50% for 2001 and 50% for 2002. But this amount does not get transferred to line 15(b) in Form 1040, which shows zero. However, if I checked the box to pay the entire taxable amount calculated in Form 8606-S, the entire taxable amount does get transferred to line 15(b) in Form 1040. Clearly, TurboTax Deluxe has a software bug and cannot deal with the default case of paying 50% in 2001 and 50% in 2002. Since I cannot type the 50% amount into line 15(b) of Form 1040, I don’t know what to do other than filling out my return by hand:(

  13. I’ve tried the fix you’ve mentioned, and a number of others posted on turbo tax. Unfortunately, no matter what I do, I can’t get the conversion to be handled properly. I have used TT for 8 years, and now I have to take my taxes to a professional becuase TT can’t handle this situation.

  14. I converted some of my TIAA tax deferred account into a Roth last year and wanted to pay the tax in 2010 so that the roth would be all after-tax dollars. My TIAA agent advised me to have the fed and state tax withheld and then she put the balance into a new Roth. I received two 1099R forms from TIAA – one with the gross distr = taxable distrib = total tax withheld (so 100% was tax). This was marked 7 for normal distribution. the second 1099R had for the Gross=Taxable the amount that went into the Roth. It was marked G for Rollover. When I entered this into Turbo, the program treated the part marked G as Rollover and gave me a big tax refund. But this means that I will have to pay tax when I redeem the Roth. I have tried unsuccessfully to override this Rollover. In the interview questions after I enter the 1099R info, I checked all sorts of different combinations but still get the big (and incorrect) tax refund. Suggestions??

  15. Oh. So. Close.

    I was excited to find this thread… As Mr. Meighan suggested, I was checking the Roth contribution box.

    For context… I have several years of non-deductible tIRA contributions that I rolled over in 2010, plus I still plan to make my tIRA contribution for 2010 and directly roll it over.

    The pre-2010 conversions seemed to work just fine in TT, but when I put in my 2010 1099-R in income and my tIRA contributions on deductions it’s acting like I owe additional taxes on the $5K. On the IRA Info Wks form line 35 — Conversion Contributions Taxable at conversion — has the $5K there. Any thoughts on how I might fix it?

  16. i also have the same problem as qqq. i converted a traditional irt to roth. and the tt deluxe didn’t think that’s taxable. the program didn’t ask me if i want to pay tax now or split it into 2 years.

    very frustrating. tech support told me to buy tt premier. but based on what qqq wrote, premier version doesn’t fix this problem either.

    i guess i will have to do it by hand then.

  17. Bob Meighan,

    Myself and a few others I have spoke to are loyal Turbo Tax users and find ourselves in the same boat as many of the previous posters (Alan Rouse). Having issues with 401K/IRA rollovers, conversions into Roth IRA etc. Have not attempted your tip yet, but look forward to trying later today. I’m sure a video would help many users and reduce a large number a support calls I am sure you are experiencing.

    Now if you could only help get rid of that pesky AMT ;)

  18. After reading some earlier posts, I believe the error many MAY be making is indicating that you are making a Roth contribution. DO NOT check the box in the IRA Deduction section indicating you have made a ROTH contribution. This will cause the problems many are having. What I often have customers do is delete these forms from the return (in Forms mode) since they have erroneous info:

    1. The IRA contribution worksheet

    2. The IRA Info worksheet

    3. Form 1099-R for the conversion

    Then i go through the process again.

    Bob Meighan

    VP, TurboTax

  19. Alan Rouse… To achieve the result you want, follow these steps:

    1. Enter the IRA distribution first from the conversion of the IRA contribution to Roth. This is done in the income section under Retirement/Pensions.

    2. The Form 1099-R should show an amount in boxes 1 and 2a. The box for Not Determined is probably checked. Enter everything just as it appears on your Form 1099-R.

    3. The distribution code should be 2 (although it could be different).

    4. There will be a question about the basis in your IRA for 2009. Make sure you enter this.

    5. When done here, you’ll then eventually enter the (nondeductible) IRA contribution in the Deduction section. Based on your income, it will determine that it is not deductible. TurboTax will also determine you have basis in this contribution equal to your contribution since it was not deductible.

    6. Caution– Make sure you do NOT indicate you made a Roth contribution. This is the mistake I see many people make.

    In the end, the IRA contribution will be nondeductible, but you’ll be able to convert the funds into a Roth just as you intended. Net result, no tax on the conversion.

    If I get time, will put a short video together showing this since it is a common question.

    Bob Meighan

    VP, TurboTax

  20. Even if you and your wife are well above the IRS $179,000 limit for a Roth contribution and don’t qualify taking even a partial deduction for a traditional IRA contribution, you can still put $5,000 ($6,000 if you’re old enough) each intyo Roth IRAs, assuming you’re not yet 70.5 years old by contributing to a nondeductible IRA then converting the nondeductible IRA to a Roth. However, I’m not having any luck getting the Turbo-Tax software to cooperate in recording these transactions onto our tax return. Would welcome hearing from anyone with a solution for this.

  21. It’s just not working at all to get the correct taxable amount for a trad to roth conversion. Useless, I guess I can no longer use TT for taxes, they blew this one.

  22. My wife and I each contributed $5000 to non-deductible traditonal IRA in 2010, and we converted it to Roth IRA in late 2010. In Turbotax, it says that our AGI is too high to convert the $5000 to roth IRA in 2010, and we have to pay penalty for the $5000 in the roth IRA despite that its after-tax money (we have no pre-tax contribution). Turbotax suggests us to convert it back to traditional IRA to avoid that tax. Does this make sense? Should we convert it back to traditional IRA? How can we correct it in Turbotax?

  23. Reading the article, I just realized if you did your conversion in 2010, you will be tax only in 2011 and 2012. This is why I did not see the tax increase and I thought that was TurboTax bug. Duh!

  24. I’m struggling with the Roth conversion as well, only with a different issue. 2010 taxes don’t go up with the Roth conversion because the default setting is to take advantage of the rule that 1/2 your income converts in 2011 and 1/2 in 2012.

    My issue is that when I plug in the remaining value of my traditional IRA, my tax liability keeps increasing. Makes no sense. If I don’t report to the government what is left I pay less taxes than if I tell them? Hopefully Intuit will work out these conversion bugs in a update release soon.

  25. Remember! The “cost basis” for a converted IRA is the entire amount. If you have $200,000-$300,000 in your IRA you MUST pay tax on the entire amt – either in one lump or over two years. For us it’s a no-brainer since we’re in our 50’s & expect taxes to skyrocket.

  26. I too spent over an hour on the chat line with a intuit rep that was clueless to my questions on the Traditional to Roth conversion. I have Turbo Deluxe and the Federal piece is working the way it is suppose too. For 2010 only, any Roth conversion taxes can be deferred until 2011 & 2012 so it would NOT change 2010 tax implications, it will get carried over to the 2011 form and then 2012. My problem however is that the State turbotax is bringing the entire thing over to 2010 and calculating the entire tax in 2010 which will totally mess up 2011 & 2012. The solution from the chat person was to override this and delete it from State. I believe this is then going to give me problems with e-filing because I have something overridden. Hopefully they will fix the State program in a future release. Hope this helps you out.

  27. I have been struggling trying to enter my conversion of money from a traditional IRA to a Roth IRA. I can see that turbo tax premier is not handling it correctly because my tax due does not change when the amount is entered. I have wasted 4 hours (really) with well-meaning but clueless intuit employees on their chat line, full of irrelevant suggestions and wild guesses about what to do. However, I refuse to pay $30 per hour to talk to some so-called tax expert because this program is so unintuitive in how something like this can not only be entered, but even found in the comment section. Presumably the financial benefits will be worth the aggravation of dealing with intuit – in the long run!

  28. Do you have any information on Roth Conversions? Must they be made by 12/31/yyyy, or April 15 of the following year?

    Thanks.

  29. Is there a calculator for converting traditional ira to a roth ira considering the one time allowance this year? age 74, no earnings, etc. all income is savings & pensions.

  30. Pingback: My IRA Conversion Guest Post » JoeTaxpayer

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