Non-Deductible IRA to Roth Conversion

Heather Comella, CFP®
24 Jun

Finance terminology can sometimes feel like a foreign language. Perhaps you’ve heard of a Roth IRA, or even a “Backdoor Roth” and you thought “what does a door have to do with retirement savings?” I’m happy to break this down for you so you can educate all your friends about these financial planning strategies for retirement savings.

Can you remind me what a Roth IRA is again? 

Unlike a traditional retirement contribution, when you make a Roth contribution you are fore-going the tax deduction for this income today, for the benefit of withdrawing the funds later during retirement tax-free (if withdrawn after the age of 59.5). If you are in a lower tax bracket today than you anticipate during retirement, this may be tax-advantageous for you. Alternatively, if you do not intend to use all your retirement savings during your lifetime, it is also tax-advantageous for your non-spouse heirs to inherit a Roth IRA over a Traditional IRA account*. We’ve got an entire article devoted to the difference between these accounts if you want to learn more. 

Can everyone utilize a Roth IRA? 

With this versatility, Roth IRA’s provide a great financial planning opportunity. However, there are income limits that prohibit everyone from contributing to Roth IRAs. For higher-earning individuals, the amount you can contribute to a Roth IRA begins to “phase out” until the ability to contribute is eliminated completely. In 2020, a single person making <$124,000 Modified AGI (MAGI) can make the full Roth IRA contribution amount ($6,000 if under the age of 50 or an additional catch-up contribution of $1,000 is allowed over the age of 50 for a total contribution limit of $7,000). A single person with MAGI between $124,000 - $139,000 can contribute a reduced amount to their Roth IRA, and if they make over $139,000 they cannot contribute to a Roth IRA at all! See the IRS limits for other filing tax statuses here.

Ah shucks. What a great account and yet many folks won’t have an opportunity to invest in it. Not so fast! For individuals who are not able to contribute to a Roth IRA because they are over the income limit, there is an alternative tax strategy available. These individuals can make a non-deductible contribution to a Traditional IRA account which creates “basis” in the account (essentially contributing with after-tax money). If you have basis in your Traditional IRA account equal to the account value, you can convert the Traditional IRA to a Roth IRA without triggering a taxable event (because it is after-tax money moving to an after-tax retirement account). 

Once the funds are in your Roth IRA account, you can invest them to your target allocation and enjoy the same tax benefits as if you had made the Roth IRA contribution directly. Pretty cool from our perspective. 

What are the restrictions? 

The IRS considers the combined total of all your Traditional IRA accounts when determining the taxability of a Roth conversion. They will apply the basis pro-rata to the amount converted. For example, let’s say you have the following accounts:

  • You made a non-deductible contribution of $6,000 to Traditional IRA #1 therefore you have basis in this account. 
  • Your Rollover Traditional IRA #2 was funded when you rolled your old 401k from a previous employer into this IRA account. The contributions to the 401k account were deducted in the year they were made (i.e. this is pre-tax money) therefore you do not have any basis in this account.

If you were to try to convert 100% of Traditional IRA #1 to a Roth IRA, the IRS would aggregate your Traditional IRA accounts (both IRA #1 and #2 listed above) and apply the basis for the aggregated accounts pro-rata to the amount you converted. You have $12,000 of aggregated Traditional IRA assets, with a total of $6,000 of basis; therefore 50% of your conversion is taxable. In this case, you would be taxed on $3,000 (.5 X $6,000 without basis) at ordinary income tax rates if you converted all of Traditional IRA #1. 

What if I’ve already rolled a previous employer 401k into a Rollover IRA?

For this reason stated above, this strategy is best executed if no other Traditional IRA assets exist. However, if you have existing Traditional IRA assets that prevent you from doing a tax-free Roth conversion, consider rolling the IRA into your current employer’s 401k account. Once the assets are in a 401k account, they are no longer considered by the IRS when aggregating your IRA accounts. 

So who is using these non-deductible IRA to Roth conversions?

The first type of person that would benefit from this strategy is someone who is making above the AGI limits and has already contributed the maximum allowed to a company retirement plan. Utilizing the Roth conversion allows them to sock away an additional $6,000 in a tax beneficial way. 

The second type of person that would benefit from this would be someone who is not covered by a company retirement plan but their spouse does have access to one. If their joint income is above the MAGI limits and one spouse has access to an employer plan they cannot benefit from a Traditional IRA contribution therefore they should convert this to a Roth in the manner we are describing. 

How do I do it? 

Before you begin the process, please reach out to your Origin Planner for additional help in determining if this strategy is appropriate for you. If you’re ready to move forward with implementing this strategy, however, we’ve detailed the steps below. 

Although it may look like a complicated process, this strategy is relatively simple; however, it’s important to do this in the correct order. 

  1. Open a Traditional IRA and a Roth IRA account. You can open these accounts at Charles Schwab, Fidelity, or Vanguard for example. For simplicity, we recommend you keep your Traditional IRA and Roth IRA at the same institution. 
  2. Make a contribution to your Traditional IRA account up to the current year's limit (Click here to see current contribution limits as set by the IRS). 
  3. Contact the custodian of the Traditional IRA and ask them to send you any paperwork required to move the money from your Traditional IRA to the new Roth IRA. To ensure you are properly documenting the move you should make sure to select the same trustee transfer to ensure the funds move directly from your Traditional IRA to your new Roth IRA.
  4. Notify your tax preparer that this is a non-deductible IRA contribution.

It’s important to note that you may want to do this annually and each time you would repeat steps 2-4 above. The deadline for making your annual contribution is the tax filing deadline for that year (i.e. for 2020 the contribution must be made by April 15th, 2021). 


*Current law requires non-spouse beneficiaries that inherit Traditional or Roth IRA accounts to distribute the balance within 10 years of the decedent's passing or incur penalties. For larger inherited Traditional IRA accounts these distributions will push the beneficiaries into high-income tax brackets therefore they will pay a larger percentage of income taxes on the distributions. For younger beneficiaries in their working years they may already be climbing through the tax brackets, and adding these distributions to their taxable income at higher rates will be noticeable. In contrast, inherited Roth IRAs must also be distributed within 10 years of the decedent’s passing however the distributions are not taxable. There are certain eligible beneficiaries who are not subject to the 10-year distribution rule. Eligible beneficiaries include a surviving spouse, a minor child of the deceased owner, disabled or chronically ill individual, or any other person who is not more than 10 years younger than the deceased account holder. Eligible designated beneficiaries have the option to take Required Minimum Distributions based on their life expectancy.