Nondeductible IRA contributions make Roth IRA conversions more complicated. Suppose, for example, that Harry Walker retired with $175,000 in his employer’s retirement plan, all from pretax contributions. He rolled that into a traditional IRA.
Also suppose that Harry made $20,000 of non-deductible contributions to another traditional IRA. He now has $25,000 in that account.
Harry would like to convert the $25,000 traditional IRA to a Roth IRA because he has only $5,000 of pretax money that would be subject to income tax in that IRA. However, the tax code states that all of a taxpayer’s traditional IRA money must be counted, for the purpose of taxing a Roth IRA conversion.
In this example, Harry has a total of $200,000 in traditional IRAs. His $20,000 of aftertax money is 10% of the total.
Therefore, when Harry converts any or all of his traditional IRAs to a Roth IRA, 10% will be tax-free and the other 90% will be taxable. In the future, Harry will have to keep track of any aftertax money left in his traditional IRAs so he can calculate the tax on traditional IRA withdrawals and Roth IRA conversions.
