Tax result of Roth Conversion plus a Trad IRA Contribution

[Anonymous]

Question-1: Will an IRA to Roth conversion in 2020 and then a separate Trad IRA contribution in early 2021 (for tax year 2020) of the same $ amount result in a net zero tax liability? My thinking is that the Roth conversion of say $5K will increase the income by $5K, and then the Trad IRA contribution of $5K will decrease the income by the same amount, hence zero in tax liability?

Question-2: From a purely tax return perspective, is a contribution to a Roth IRA of say $5K, essentially same as doing a $5K conversion from IRA to Roth instead? In other words, either transaction on its own will increase the income by $5K and hence result in the same tax liability?

TIA.

[NCperson]

are you over or under 59.5 years old? 

[Anonymous]

Under

[NCperson]

there is a 10% tax penalty for traditional IRA distribution if you are under 59.5 years old. 

answers to your two questions. 

1) your strategy will not result in zero tax liability

2) no. 

[Anonymous]

@NCperson Thank you for taking the time to respond.  I was wondering why you asked me the age question and now I understand - It appears that I was not clear enough in my questions and you misunderstood.

Let me clarify: I don't intend to pay the distribution tax from the retirement account, rather from my bank account.  That eliminates the 10% penalty since the converted amount is considered a direct rollover from Transitional IRA to Roth.  I have been converting every year (that made financial sense) and have never been subject to any penalty.

[dmertz · Accepted solution]

1.  There will be no change in tax liability.  A Roth conversion is not subject to any early-distribution penalty regardless of your age, so, assuming that you have no basis in nondeductible traditional IRA contributions and your traditional IRA contribution for 2020 made in 2021 is deductible, the deductible traditional IRA contribution will offset the increase in income from the Roth conversion and there will be no net change in AGI.

2.  No.  A Roth contribution adds to your overall retirement savings without changing your AGI.  A Roth conversion results in no change to the amount of your retirement savings but adds the taxable amount to your AGI.  The benefit of a Roth conversion is that you pay the taxes now on what is presently deferred income in the traditional IRA for the privilege of getting tax-free growth in the Roth IRA instead of tax-deferred growth in the traditional IRA.

Regarding #2, if you were instead asking if there is any difference between just making a Roth IRA contribution and doing what you proposed in question 1, there would be no difference given the assumptions I expressed.  However, some people could be ineligible to make a Roth IRA contribution due to AGI being too high, so what you proposed in question 1 can be a way to get money into a Roth IRA that cannot be contributed directly to the Roth IRA.

[Anonymous]

@dmertz, Your third paragraph was exactly what I was asking.  THANK YOU for your time and the responses - I am all clear.