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# Convert Nondeductible Contributions Carefully

Follow the rules for moving after-tax contributions into a Roth, so you don't accidentally pay Uncle Sam twice.

Did you stash nondeductible contributions into an IRA with the goal of converting them to a Roth IRA in 2010 or beyond? Although you've already paid income tax on nondeductible contributions, you can't just simply transfer them tax-free to a Roth.

The rules for moving after-tax contributions are complex, but if you follow them, you won't accidentally pay Uncle Sam twice. You can make nondeductible IRA contributions of up to \$6,000 for 2010 if you are age 50 or older and don't qualify for deductible contributions.

When your IRAs include nondeductible contributions, only a portion of the conversion -- a prorated amount of your total IRA assets -- will be tax-free. "The pro rata rule precludes you from targeting particular accounts," says June Walbert, a certified financial planner for USAA.

You have to figure the ratio of the nondeductible contributions to the total amount you own in all of your traditional IRAs. You use that ratio to determine how much you can convert free of taxes. Any Roth IRAs you own are not counted in the calculation.

Let's say you have two traditional IRAs -- one holding \$200,000 in pretax contributions and earnings, and another IRA holding \$100,000 in nondeductible contributions and \$50,000 of earnings. That gives you a total of \$350,000 in IRA money.

You'd like to convert \$100,000. You must first figure the tax-free ratio of your nondeductible contributions to your total IRA money. That would be 29%, or \$100,000 divided by \$350,000.

Multiply that percentage by the amount being converted to arrive at the tax-free amount. In this instance, \$29,000 of the \$100,000 conversion would be tax-free. Tax would be owed on \$71,000.

If you plan to do multiple conversions over several years, the ratio will change because the total amount in your IRAs will fluctuate with the market and any contributions or withdrawals. Every time you convert, you would need to refigure the pro rata calculation.

Record keeping is critical. You must file IRS Form 8606 when you make nondeductible contributions. Keep these forms and the accompanying tax returns. Also hold on to Form 5498, which shows your IRA contributions and balances for the year, and Form 1099-R, which shows distributions. These forms, which are issued by your IRA sponsor, will help you calculate the prorated tax-free amount.

### Mind the Details

When doing the pro rata calculation while completing your tax return, you will use the total value of your IRA assets on December 31 of the tax year. Your projections of the tax-free ratio for a conversion made earlier in the year can change if your year-end IRA balances change.