Saving Tax Dollars on Your Roth Conversion

One of the “hot” tax topics for 2010 is the Roth Conversion. Beginning in 2010, Congress will permit anyone, regardless of income level, to convert money from retirement accounts and traditional IRAs to a Roth IRA. Much has already been written about the pros and cons. (For a review, please read Mark Stinson’s article, “Should I Convert to a Roth IRA”.

This article assumes that you’ve already decided to convert. We’re pointing out a way to reduce the taxes you’ll pay on the amount you convert.

Let’s quickly revisit the tax consequences of a Roth conversion. In general, the money you move from a retirement account or a traditional IRA will be taxable. The taxes on 2010 conversions can be paid in two installments, in 2011 and 2012. You can reduce the taxes if any of the converted money is after-tax money. After-tax money is also called “cost basis” in tax jargon. After-tax money is normally the non-deductible contributions you’ve made to your retirement plans and IRAs in past years. Since you’ve already paid taxes on this money, you don’t have to pay taxes again on the conversion.

The IRS tracks your after-tax contributions by looking for Form 8606 to be included with your yearly tax filing. Among the several items reported on this form is the current year’s after-tax contribution and the cumulative total of all such contributions. It’s very important that this form be filed in every year when an after-tax contribution is made. If you’re married, each spouse must include his or her individual Form 8606.

If you have not filed Form 8606, or if you’re not sure you filed it, you can file it as a separate form at any time. It’s very important that you update your records with the IRS. You don’t want to pay tax on the money you convert to a Roth a second time.

You calculate the non-taxable portion by starting with the total after-tax contributions to your IRA and dividing that by the total value of your IRA at the end of last year. Then, you multiply this ratio times the total conversion to determine the non-taxable portion.


Taxes on a Roth Conversion
Total non-taxable contributions to your IRA
from IRS Form 8606
Value of your IRA as of 12/31/08 $100,000
Ratio of non-taxable conversion
Total non-taxable contributions to your IRA
Divided by Value of your IRA ($100,000) =
Total Conversion Amount
(an amount selected by you)
Non-taxable amount of conversion
25% x Total Conversion Amount ($50,000) =
Tax savings at 25% federal rate $3,125



Importance of Form 8606 – Beyond the Roth IRA Conversion

Form 8606 is important even if you don’t plan on converting to a Roth IRA. Here’s why: when you begin taking money out of your traditional IRA, the portion of each distribution that represents your after-tax contributions to your IRA will not be taxable. In other words, if 30% of your traditional IRA was contributed after-tax, then when you take money out of the IRA during retirement, 30% will not be taxed. (Remember that your Roth distributions are not taxed because you paid the taxes upfront.)


BWFA prepares the Form 8606 for our tax clients every year they make an after-tax contribution. We also keep the cumulative total of after-tax basis on our clients’ IRAs. Your IRA basis is often one of the things that is lost when you prepare your own tax returns, change tax software from one year to the next, or change tax preparers. The potential for losing this information is why we ask new clients for prior years’ tax returns, and why we specifically look for after-tax contributions to your IRAs.

Please call your advisor if you have any questions about after-tax contributions and tax basis in your IRAs. We’re also here to help.