The Taxing Side of IRA Conversions

A recent article entitled When to Switch to a Roth IRA discussed opening a non-deductible IRA and converting it to a Roth in 2010. As a married person filing jointly, can I open a non-deductible IRA in my name and then convert just my IRA accounts in 2010? My husband has too much money to convert all of his accounts, but I have just a little bit of money in my IRAs.

Your tax bill may be smaller than your husband's if you only convert your own accounts. But he doesn't have to convert all of his IRAs, either. He can convert just a portion of his accounts. Then the size of his tax bill will depend on how much he converts and how much of his contributions were tax-deductible versus non-deductible.

Currently, people can convert traditional IRAs to Roths only in years when their adjusted gross income is less than $100,000 -- a limit that applies both to single filers as well as those who are married filing jointly. But that income limit disappears starting in 2010. At that point, anyone can convert a traditional IRA to Roth, regardless of income.

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But there is one catch: You'll have to pay taxes on the conversion. If you've only made tax-deductible contributions, then the calculation is easy: The full amount of the conversion will be taxed at your top income-tax rate. If you have made non-deductible contributions, then part of the conversion will be tax free -- you're only taxed on the earnings from non-deductible contributions, not the non-deductible contributions themselves.

You can't minimize your tax bill by converting only the non-deductible contributions. If you only convert some money from your traditional IRAs, then the portion that escapes taxes is based on the ratio of non-deductible contributions to the total balance in all of your IRAs. If your total balance is $100,000, for example, of which $20,000 represents nondeductible contributions, then 20% of any conversion would be tax free.

That means if your husband made a lot of tax-deductible contributions or had a big rollover from a pre-tax 401(k), then he could face a big tax bill for making the conversion to a Roth -- even if he only converts a portion of his IRAs. Anyone who converts a Roth in 2010, however, does have the option of paying his or her tax bill over two years, in 2011 and 2012.

Your own accounts are treated separately from your husband's. So if you've only made non-deductible IRA contributions and convert all of your IRAs, then you'll only need to pay taxes on the earnings -- not the original contributions.

If you haven't made any IRA contributions in the past and then make non-deductible contributions of $5,000 in 2008 and 2009, for example, then $10,000 of the conversion will be tax free and you'll only be taxed on the earnings.

You'll be able to withdraw all of the money from the Roth tax-free after age 59½, as long as you've had a Roth for at least five years. It's a great backdoor way into a Roth if your income is too high to qualify to make contributions directly into the account. For more information about this strategy, see Tax-Free Income for All and Backdoor Roth IRA. For details about the income limits, see Why You Need a Roth IRA.

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.