Q: I make too much to save in a Roth IRA. Currently I have 3 Roth IRA’s begun when I was salary eligible) and 403-B’s. I also have a Rollover IRA. I would like to put $6000 into a new non-deductible IRA and then convert it the following week into a Roth IRA. I had though I would then pay taxes only on any increase in capital for that week. However, someone said I would need to pay taxes on more than this non-deductible IRA which makes no sense to me. What is your answer?
A: This is a good question and a common one.
If you have an IRA that is still pre-tax and now a new “post-tax”/non-deductible IRA, it is not as simple as just converting the non-deductble portion. You will be required to pay taxes on the pro-rata portion of the contribution that you converted. Let’s assume that you fund your non-deductible IRAs with $6K for both you and your spouse for a total of $12K. Let’s also assume that your rollover IRA is valued at $88K. Under this scenario, your IRAs would total $100K. If you decided to convert the $12K of non-deductible contributions, the IRS looks as this as 12% of your overall IRA balance. Therefore, regardless of whether the conversion was of non-deductible or deductible contributions, you will have to pay taxes on 88% of the amount converted.
This is a good article for futher reference: http://taxes.about.com/od/retirementtaxes/a/Roth-IRA-Conversions_2.htm