Nondeductible IRA to Roth in 2010

Julie writes:
I am thinking of making non-deductible IRA contributions this year and on and then convert to Roth IRA in 2010, as described here:

http://finance.yahoo.com/columnist/article/moneymatters/16201

I already have a deductible Rollover IRA and Roth IRA. However my income is over the limit for Roth IRA contributions. Also my company has a 401K to which I contribute. Up to now I saw no advantage to making non-deductible IRA contributions.

To make non-deductible IRA contributions do I need to open a new non-deductible IRA account, distinct from my rollover IRA?

If I can make non-deductible contributions to the Rollover IRA and keep a single IRA account, what records do I (or the custodian) need to compute the value of the non-deductible contributions in 2010?

By when do I need to open a non-deductible IRA and fund it with 2007 contributions: before Dec 31, 2007 or April 15, 2008?

In 2010 can I rollover the non-deductible IRA into my current Roth IRA or do I need a separate Roth IRA?

Thanks in advance for your expertise and time.

My Reply:

First, one Roth IRA is sufficient. You do not need to open a separate Roth IRA for this maneuver.

Second, you could convert your entire Traditional IRA beginning in 2010, assuming that Congress doesn't change the law. If you did this, you would owe income taxes (no penalties) on your deductible contributions and earnings. Thus, if you have a sizable amount in your Traditional IRA, you may want to convert a portion at a time so you don't throw yourself into a higher tax bracket. For what is converted in 2010, you can spread the tax over 2 years. For amounts converted after that, the tax will need to be paid with taxes for that tax year.

Third, since you already have a deductible IRA, you need to be aware that you cannot convert only the nondeductible IRA. It's important to be aware that conversions are done on a percentage allocation only. For example, if you have $10,000 in nondeductible contributions and $90,000 in earnings and deductible
contributions between your Rollover IRA and your nondeductible IRA and you convert $10,000, you will be converting $1,000 of nondeductible contributions and $9,000 of deductible contributions and earnings.

Again, you will owe tax on the $9,000 (the portion of your conversion which were deductible contribution and earnings).

Please note: In order to obtain the maximum benefit from this strategy you should have adequate funds to pay the taxes due outside of your IRA account. If you take money from your traditional IRA to pay the tax on the conversion, it's a taxable distribution subject to the premature distribution penalty (if you're under 59 1/2).

You have until the due date of your tax return to make your nondeductible contributions for the prior year; thus you will have until April 15, 2008 to make your 2007 nondeductible IRA contributions.

When you make nondeductible contributions to an IRA you file Form 8606 with your tax return. You will need this form in order to compute the value of the nondeductible contributions.

Best wishes,
Gina
GLGcpa.com