Making Your Money Last
A Sweet Deal on Roth IRA Conversions
If you earn too much to qualify in 2009, set your sights to convert to a Roth in 2010.
By Mary Beth Franklin, Senior Editor
From Kiplinger's Personal Finance magazine, January 2009
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Employees who make (or who have made) after-tax contributions to their employer's retirement plan, listen up. You can now take that money and convert it to a Roth IRA tax-free.
To qualify for a Roth conversion, your adjusted gross income may not exceed $100,000, whether you are single or married. But don't despair if you make too much now; income limits on conversions disappear in 2010. Income limits on new contributions to Roth IRAs, however, will remain in effect. In 2009, individuals who make up to $120,000 and married couples who make up to $176,000 may contribute up to $5,000 to a Roth IRA, and $6,000 if they are 50 or older.
The new rule on after-tax contributions is much more liberal than the one that governs a conversion from a traditional IRA to a Roth IRA. In that case, the tax-free portion of the rollover is determined by the ratio of nondeductible pay-ins to the total amount in all of your IRAs. So if your $60,000 IRA contains $6,000 in nondeductible contributions and you convert that $6,000 to a Roth IRA, just $600, or one-tenth of the converted amount, would escape income tax. The remaining $5,400 would be taxed at your regular income-tax rate. But under the new rules for after-tax money in 401(k)s -- and 403(b)s and 457 plans -- the full $6,000 would escape taxes. Plus, there is no limit on how much you may convert.
"It's a sweet deal that lets you move money to a Roth IRA with no tax costs," says Ed Slott, a CPA and IRA expert in Rockville Centre, N.Y. "You can't do that from an IRA."
Not all retirement plans allow after-tax contributions. But if yours is among those that do, this is a great way to keep some of your retirement savings growing tax-free without paying the usual price of admission to convert to a Roth IRA. Normally, you must wait to switch jobs or retire before you can move money out of your employer-based retirement account. But some plans permit in-service distributions, allowing you to roll over some or all of your 401(k) money to an IRA once you reach age 59½.
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Reader Comments (43)
Posted by: Richard Trefflich at 12/10/2008 11:25:03 AM
I have contributed the max in pre-tax to my 401ks for years (15-20k per year). It seems that the % of folks in the post-tax 401k contributions would be minimal and thus this article would only affect an a tiny obscure number of people. So this article is of little consequence.
Posted by: buster at 12/10/2008 10:55:37 PM
In response to the comment made about the article. What you are missing is when you start withdrawning from your 401k you will pay taxes. Every single person I know who is now withdrawing say, paying the taxes at retirement hurt much more than if they'd payed with after tax dollars. So you don't get the article intent. Probably because it makes several points and (is) disjointed.
Posted by: Robert J. Berg at 12/11/2008 06:12:21 AM
I have approx $6,000 dollars in after tax contributions in my IRA from past year contributions. I am retired. Does this Roth conversion apply to me??
Posted by: Danman at 12/16/2008 09:55:26 PM
I would like to hear about how to convert a regualar pre-tax IRA to a Roth IRA and know what the cost is to do so in that tax year based on my income for that year. But not a single calulator or chart on the net seems to be able to give and estimate. That would be useful for a lot of people.
Posted by: Phineas T. Bluster at 12/17/2008 09:49:29 PM
...If you have after-tax contributions in your 401k - as many people do - inform yourself on this subject, before doing any rollovers to an IRA. Even if you are not presently contemplating such a rollover, you may find it advantageous to do so.
Posted by: Phineas T. Bluster at 12/17/2008 11:02:50 PM
Sorry Mr. Berg. This pertains to rollovers from other types of qualified plans, such as a 401k. After-tax contributions in an IRA are "basis," and must be prorated over the distribution period. If you happen to have negative taxable income, perhaps due to capital losses, and you are not yet taking distributions from your IRA, you might find benefit in converting a commensurate amount of pretax money from your IRA to a Roth IRA. A pro-rata share of your basis could be transferred to the Roth, too. It would have to be done before year end.
Posted by: Phineas T. Bluster at 12/18/2008 02:52:57 PM
Ed Slott, who is quoted in this article, has a forum called "Ed Slott's IRA Forum." It's free and is a good source of informed discussion on this and other IRA topics.
Posted by: Donald Kellett at 12/19/2008 01:01:24 PM
"But under the new rules for after-tax money in 401(k)s -- and 403(b)s and 457 plans -- the full $6,000 would escape taxes. Plus, there is no limit on how much you may convert." We were just told that because we were converting several IRAs into a ROTH, our S/S taxable income would be increased by over $3000. Is this correct? Thanks
Posted by: Phineas T. Bluster at 12/21/2008 06:09:49 PM
If you convert any pretax money to a Roth, you generate an equivalent amount of taxable income, Mr.Kellet. That can also have the effect of increasing the portion of your Social Security income that is taxable. I use tax preparation software to run "what if" scenarios. Taxact.com offers a fully-functional, "standard' version that you can download for free.
Posted by: Tom Wagner at 12/22/2008 03:34:03 PM
What I don't see in the comentary is the underlying assumptions of current taxes /future taxes and also state taxes and their effect on future draws and earnings. For simplistic purposes I ran my #s and see little reason to convert as I see little movement in lower bracket movement in tax rates. I don't see my bracket increasing and state taxes will offset any savings; and I still question the life of the roth inlight of future tax needs and the possible revocation of its vevy existance. I will hedge my betts and make new contributions to the roth and let the current iras ride.
Posted by: Phineas T. Bluster at 12/22/2008 11:10:24 PM
This article is a bit vague, probably because the IRS hasn't issued the pertinent regulations yet, Mr. Wagner. The "sweet deal" isn't about converting pretax money to a Roth, which would generate taxable income. It's about getting after-tax money out of a 401k and into a Roth, without generating taxable income and getting the benefit of tax-free growth thereafter.
Posted by: R Sink at 12/31/2008 12:36:08 PM
I was all set to do a conversion from my regular IRA's "After tax" portion to the a new ROTH. I am on hold because the commentary seems to suggest that "regular" IRAs don't qualify. Can anyone enlighten me?
Posted by: Mary Beth at 01/01/2009 11:08:36 AM
Hi, this is Mary Beth Franklin, author of this column. To R Sink: When you convert a traditional IRA that contains both pre-tax and after-tax contributions to a Roth IRA, any amount you convert is on a prorata basis. You can't cherry pick the after-tax money and convert only that amount to a Roth IRA tax free. As the article above explains if your have a $6,000 IRA balance and $600 or 10% of the balance comes from after-tax contributions, only 1/10 of ANY amount you convert to a Roth IRA would escape taxes. That's why converting after-tax money from a 401(k) or similar workplace-based retirement account to a Roth IRA is such a sweet deal. There is no prorata rule. You can convert all of your after-tax money in a 401(k) directly to a Roth IRA without paying taxes. Keep in mind, very few 401(k) plans allow after-tax contributions... it's often an option that was reserved for execs and other high-paid employees who weren't able to contribute the maximum pre-tax amount to their retirement plans in past years due to anti-discrimination testing. Hope this helps.
Posted by: dederd2 at 01/24/2009 05:55:17 PM
Now I am totally confused. Well, ok, even more confused than usual. I had a TSP that I rolled over into a SIRA two years ago. I now want to convert part of that SIRA into my Roth IRA that I fully funded with after tax funds. I had always understood that if I did a conversion of a SIRA to a ROTH that the entire converted amount was subject to taxes. Yes/no? Also, am I correct in my thinking that I can do a partial conversion of the SIRA and then do another partial conversion in succeeding years?
Posted by: Quant Jock at 01/27/2009 08:16:34 PM
Please don't forget that any Traditional to Roth IRA conversions that you pay taxes on could be potentially taxes paid on assets that you no longer have if the market turns down. In other words, you will pay taxes for nothing! Let's hope our assets grow in value over time.
Posted by: ottoknowbetter at 01/28/2009 07:52:39 PM
Mary Beth - My former employer's retirement plan started before 401ks so I have a substantial amount of after-tax contributions in the plan. If I rollover the after-tax contributions to a Roth IRA and rollover the remaining balance to a Traditional IRA can I avoid paying tax on the total conversion? Please cite the authority for this position.
Posted by: gerald law at 02/28/2009 06:30:35 PM
I am retired and have a regular IRA that has lost more than 50% of its value in 2008. Can I convert this to a roth tax free?
Posted by: oc at 03/04/2009 12:23:24 PM
Do we contact our 401k plan administrator to find out if we can convert our 401k to Roth ?
Posted by: Ben at 04/07/2009 08:30:27 PM
oc, You may want to read rothirarules.net/roth-ira-conversion.htm - they have some good info on conversions and roth ira overall
Posted by: G. Perkinson at 05/01/2009 03:38:25 PM
In re the change in Roth IRA eligibility rules in 2010 (Jan. '09),other than allowing annual contributions to an IRA, how would a change to a Roth IRA benefit someone who is over 70 1/2, has income from Soc. Sec., an annuity, and investments?
Posted by: Jason at 07/21/2009 08:29:50 AM
Wow, this is great news! I was wondering a couple of things about this that perhaps you could clarify. Can you only convert post-tax 401k contributions that were made during 2009, or can the contributions be made through all of 2010? Are you only allowed to make such a conversion once? If someone were to qualify for the conversion in the 2009 tax year, but not the 2010 tax year, would she still be able to make the conversion in 2010 based on 2009 income?
Posted by: Mary Beth Franklin at 07/21/2009 11:34:57 AM
hi gang, this is Mary Beth, author of this article. There's lots of questions here. Let me see if I can answer them all. In most cases, any contributions you make to a 401(k) or similar workplace-based retirement savings plans are pre-tax. If you convert that money to a Roth IRA when you leave your job or retire, you will have to pay taxes on the entire amount at your regular tax rate and through the end of 2009, you can only convert to a Roth IRA if you income is $100,000 or less. Starting in 2010, anyone, regardless of income, can covert to a Roth IRA (and pay taxes) but income eligibility limits will remain in effect for contributions to a Roth IRA.... see my next post for more....
Posted by: Mary Beth Franklin at 07/21/2009 11:37:34 AM
Mary Beth again, here's more. The above article deals with the rare case of individuals who have AFTER-Tax contributions in their 401(k)s or similar workplace retirement savings plans. In that case, when they leave their jobs, they can convert their after-tax contributions to a Roth IRA TAX free (assuming their AGI doesn't exceed $100,000 in 2009) and they can rollover their regular pre-tax contributions and earnings to a traditional IRA to preserve the tax deferral until they start withdrawing them money.... See one more post
Posted by: Mary Beth Franklin at 07/21/2009 11:42:15 AM
Here's my last post. For the reader with the question about contributing to a Roth IRA after age 70 1/2: yes you can contribute to a Roth IRA, regardless of age, as long as you have earned income from a job and meet the income eligibility requirements for contributions: $105,000 for individuals (phase out for partial contribution up to $120,000); $166,000 for married couples filing jointly (phase out for partial contributions up to $176,000). there is no up front tax break for Roth contributions, but your money will grow tax free and you can begin tax-free distributions once the account has been open five years (and you're at least 59 1/2 years old. Roth IRAs have no mandatory distribution requirements. Hope this helps everyone. Thanks for your questions.
Posted by: James at 08/02/2009 12:43:31 PM
I am 72. If I convert my regular IRA to a Roth IRA in 2010, will I be restricted from withdrawal from that Roth IRA for five years? And, if I do withdraw funds from the Roth before five years after conversion, will there be a penalty?
Posted by: Randy Darr at 08/08/2009 10:24:35 PM
I had read that if you have more than 1 IRA, say one before tax and 1 after-tax, that you had to convert both and use a ratio of before tax to after tax to calulate the tax ratio. Is this correct or could you choose to convert only the after tax IRA?
Posted by: Frank at 08/29/2009 03:12:38 PM
Does the money that you convert count as income toward the $100K AGI limit? For example, if my AGI without the conversion is $70K and I convert $40K to Roth, is my new AGI $110K?
Posted by: CJ at 12/01/2009 02:37:58 PM
I was wondering which Code section or Regulation allows an individual to "cherry pick" the after-tax contributions made to a 401(k) (that also includes pre-tax contributions) in order to convert them to a Roth IRA tax free. The October 2009 Kiplinger Tax Letter also makes this claim. However, I've been looking and I can't seem to find this authority anywhere.
Posted by: Daqn at 12/15/2009 11:52:25 AM
I ran the numbers in an MS Excel spreadsheet. The real-world numbers with full tax implications shows zero difference in the in-you-wallet amounts between traditional IRA and ROTH. Zero difference. Roth IRAs have some age-related loopholes but no tax advantages. Sorry.
Posted by: peter schnapp at 12/20/2009 07:28:56 PM
Just want to make sure I understand it right: you don't pay taxes if you convert traditional IRA funded with after tax (non-deductible) money only to Roth IRA. Right/wrong?
Posted by: Walter Bueschel at 01/12/2010 11:07:50 AM
With the new 2010 conversion rules; can an existing employee convert his current 401k to a Roth IRA, without a qualifying event; such as losing his job ? Thanks.
Posted by: W. Houck at 01/12/2010 12:48:07 PM
I had 20K post- tax dollars in a 401K with Fidelity. Fidelity told me to do the exact same conversion this article discusses. I now have 20K growing tax-free in a ROTH IRA and without any future distribution requirements with no tax consequences for this conversion. The remaining part of my 401K got rolled over to a traditional IRA, again with no tax consequences. Excellent article
Posted by: W.Koeslin at 01/14/2010 07:53:16 PM
I would like to roll the already taxed portion of my 401(k) to a Roth IRA and then roll the remainder (that has not yet been taxed) to a Traditional IRA. It appears this is exactly what W. Houck posted on 01/12/2010 and what the author of this article has written. Is anyone aware of an IRS Publication that substantiates that this is allowed in 2010 and that it can be done in two non-taxable events? Thanks
Posted by: Tom B at 02/10/2010 01:10:00 PM
Mary Beth, so to be clear, if I terminate employment and have a 401 K with after and pre-tax, I can roll the after tax into a Roth and the pre-tax into a regular IRA in 2010 and incur no tax in 2010. All distributions from the Roth will be tax free after the 5 year waiting period and the regular IRA distributions will be taxable when taken. Please don't take offense but where is this conclusion written? IRS 590 is not clear on this point.
Posted by: Mary Beth Franklin at 02/12/2010 11:49:34 AM
The situation has changed since this story was first posted. In 2008, the IRS issued Notice 2008-30 explaining new rules that allowed a direct rollover of a 401(k) or other employer-based retirement plan directly to a Roth IRA. (Before 2008, it required a two-step process of rolling over the 401(k) to a traditional IRA and then converting it to a Roth IRA, subject to income taxes on the converted amount.) The notice inferred that after-tax contributions could be rolled over directly to a Roth IRA without tax. In Question 1 of the notice, the IRS said “the amount rolled over must be an eligible rollover distribution and… include in gross income any amount that would be includible if the distribution were not rolled over.” It’s IRS gobbledygook, yes, but essentially means that since after-tax contributions would not be taxable upon distribution, they would not be taxable upon direct rollover to a Roth IRA. But the IRS has since reversed its position. The American Business Conference, which represents employers, has filed an appeal. At this point, we just have to wait for a decision as to whether this is a sweet deal after all for after-tax contributions in 401(k)s to Roth IRAs. Our best advice is to sit tight for awhile.
Posted by: Tom B at 02/18/2010 07:40:18 AM
Is there a specific cite by the IRS reversing their opinion...? What caused the American Business Conference to sue? Sorry, but I'm still lost in the wilderness!
Posted by: W. Houck at 02/20/2010 02:59:29 PM
Tom B. - Notice 2009-75 was issued to clarify Notice 2008-30. Good luck with understanding either of them. My poor brain couldn't handle them. I guess I'm not fluent enough in IRS gobbledygook.
Posted by: Tom G. at 03/07/2010 08:56:26 PM
I already had completed the conversion when I read Mary Beth's update of Feb 12. I'd sure like to know where we can monitor the progress of this decision and the implication to those of us that have already converted our 401(k) after tax contributions to a Roth. I called the IRS just before I completed this conversion and explained my plan in detail and was given a thumbs up.
Posted by: W. Houck at 03/08/2010 11:09:21 AM
Nice to hear the person you talked to from the IRS said it was OK. My Fidelity rep who assured me this conversion was legit has disappeared and I can't find anyone from Fidelity who will back up his statements. Also, my calls and emails to the IRS have either gone unanswered or simply referenced the same ambigious Notices that are causing the confusion in the first place. I would guess if any clarity is ever provided it would show up in yet antother IRS notice.
Posted by: Dennis at 04/03/2010 01:06:54 PM
401(a) After-tax savings account: Now here is a topic that no one has addressed yet. I have approx. $60,000 in a 401(a) after-tax savings account with the principle at $30K. It was set up through my employer in the mid 1980's. Later the changed to me to a pre-tax 401(k) account. I have about $100,000 in the 401(k) account, wiith both totaling $160K. Question 1: Can I rollover the 401(a) $60K to my ROTH IRA under same investment firm? Question 2: What are the tax costs, if I can rollover the 401(a) after-tax to the Roth IRA, if any?
Posted by: Hashim at 08/30/2010 12:33:24 AM
Contribution to a Roth IRA is capped at $5,000 a year which is a measly amount while maximum contributions to a 401k is at $16,500 a year, 3 times as much as a Roth IRA. Anybody know why this huge difference? Maxing Out Your 401k and Roth Contributions If your income is under the threshold listed above, you can maximize your retirement savings. For 401(k) and 403(b) plans, you can contribute up to $15,000 for 2006 (or up to $20,000 if you are age 50 or older). For Roth IRAs, you can contribute up to $4,000 for 2006 (or up to $5,000 if you are age 50 or older). Source: definerothira.com Why Contribute to a Roth When You Already Have a 401k Plan? There are four good reasons why you might want to save for retirement in a Roth IRA in addition to a 401(k) or 403(b) plan. First, you may have already maxed out your 401k, and want to save more. If you are covered by a retirement plan at work, you will not be able to contribute the maximum to a tax deductible Traditional IRA. So the Roth IRA may be your only option for setting aside extra retirement savings. Second, you may want to invest in mutual funds, stocks, bonds, or certificates of deposit that are not available through your company's retirement plan. With a Roth IRA you are in full control of selecting your investments. Third, Roth IRAs do not have many of the restrictions that Traditional IRAs have. You cannot add more funds to a Traditional IRA and you must begin making withdrawals when you reach age 70 and a half. With a Roth, however, you can continue to add funds at any time (as long as you have earned income), and there's no required minimum distributions. This means you can plan out your retirement income by withdrawing money first from a 401k plan, and then tapping into a tax-free Roth IRA as needed. Fourth, tax rates might be higher in retirement than they are now. While no one can predict the future, it makes sense to put some savings into tax-free Roth IRAs as a way to protect some of your investments from higher tax rates.
Posted by: Roth IRA at 09/08/2010 07:42:41 AM
Hi everyone! - I'm currently launching my new website about Roth IRA www.rothira.org - and I'd like to welcome everyone who'd like to contribute! Thanks!
Posted by: Sue Shea at 09/20/2010 06:16:36 PM
Hi Mary Beth, Have you heard more from the IRS regrading rolling after-tax 401K to a Roth IRA Do you still advice people to do that? Thanks,