Roth Conversion

[ksblmb]

I am looking at opening a new non-deductible IRA and then converting it to a ROTH IRA. I must do this since my MAGI is too high for a direct ROTH contribution.  I would like to do this to start the 5 year clock ticking so that I can rollover my employee sponsored ROTH into this new ROTH IRA when I retire so that it would be exempt from RMDs.  However, as I already have a SEP plan I do not understand how the pro-rata tax consequences would apply.  I only want to fund the ROTH IRA with a small amount for the express purpose of starting the clock.  However, due to the pro-rata rules maybe this is not a good idea.  Does anyone have an idea how this would work or if it is even worth the hassle?

[fanfare]

 the pro-rata tax consequences will always apply if you start this process with an existing value in your IRA(s),

including SEP.

If the value is significant, only a small portion of the conversion would be tax-free.

If you convert a small amount , the tax is correspondingly small.

[Hal_Al · Accepted solution]

It's best explained by example. Let's say you have a $95,000 balance in all your existing traditional IRAs (including SEP) and that balance consist of $45,000 in deductible contributions, $10,000 in previous non-deductible contributions and $40,000 in earnings (interest, dividends & capital gains). This year you make a $5000 non-deductible contribution and convert $5000 to a Roth. Only 15% of the $5000 conversion ($750) will be tax free. Your basis, in all your IRAs, is $15,000 (the previous $10,000 of non-deductible contributions plus this year's $5000 contribution). TurboTax will divide that $15,000 basis by the $100,000 balance ($95K+5K) to arrive at the 15% tax free ratio. This is the way the IRS requires it to be done. The calculations will be shown on form 8606.

[ksblmb]

Many thanks to both you and Fanfare.  The process is now clear to me and it is reassuring that TurboTax will handle it properly.